Big Banks Have Nearly $1 Trillion Tied to AI. What If the Boom Cracks?

The Federal Reserve disclosed that the largest US bank holding companies have close to $1 trillion in exposure to firms behind the AI buildup. This figure represents a significant increase in financial ties to the technology sector.

The Fed still describes the banking system as sound, with high capital ratios. However, the report highlights a growing concern about the stability of the financial system in the face of a potential AI-related downturn.

A survey by the New York Fed found that 87% of market contacts named AI as a risk, up from 50% in the spring. This shift reflects a growing awareness of the potential for a bubble to burst.

The Fed's report details how the buildout is being financed. Borrowing for advanced computing infrastructure passed $680 billion by October of this year, about 5 times the $130 billion raised in all of 2023.

Big tech firms also back smaller, riskier developers through leases and guarantees. Neither hits the giants' balance sheets right away, but these commitments have grown even faster than the giants' debt.

Leases yet to start exceed $1 trillion, while guarantees and contract commitments top $2 trillion. The Fed points to a trade-off in these ties, noting that the largest technology firms may absorb losses in the event of a downturn.

The Fed warns that a slowdown in AI spending could trigger a downturn that would stress leveraged firms and raise loan losses at banks. The riskiest slices of these deals sit with high-yield funds, life insurers, and private debt vehicles.

Investors got a taste of the stakes earlier in November, when US stocks shed $2 trillion in an hour. Fed survey respondents warned that stretched valuations and debt-heavy funding could amplify losses in a sharper correction.

Not everyone shares that worry. Macro investor Raoul Pal has called Big Tech debt fears overblown. Banks also report strong profits, the Fed noted, and their AI-linked exposures face the annual supervisory stress test.

The Fed's outline suggests that the chain starts with an unexpected drop in corporate earnings. That makes tech earnings the next test for banks.