Financial System: AI, a potential chink in our armor

  • The Financial Stability Oversight Council (FSOC) has identified the use of artificial intelligence (AI) in financial services as a potential vulnerability in the financial system.
  • The FSOC report highlights risks such as cyber and model risks, alongside potential benefits like cost reduction and improved efficiency.
  • The report suggests ongoing monitoring of AI advancements, and enhancement of expertise to identify emerging risks.
  • It also prioritizes cybersecurity, supporting greater partnerships between state and federal agencies, private firms, and international efforts to facilitate information sharing and manage cyber-related financial stability risks.
  • For the banking sector, the FSOC encourages reviews of capital measures and improvements to resolvability regarding large, complex, or interconnected banks.

Besides AI and cybersecurity, the FSOC report touched on the modern role of non-bank financial institutions in providing financial services. In view of possible vulnerabilities and risks to the broader financial system, the Council underscored the need to keep an eye on sectors like nonbank mortgage services and private credit. Regulatory attempts to address risks associated with investment funds received the Council’s backing, as did initiatives for data collection improvements and possible reform discussions.

The report also brought attention to climate-related financial risk. Given the rising costs brought on by severe and frequent weather events, the FSOC stressed the necessity of better coordination of data and risk assessments. The Council encourages financial regulators to advocate for clear and informative disclosures for investors and financial institutions to take into account climate-related financial risks.

Lastly, the FSOC report addressed vulnerabilities in financial stability relating to digital assets. Amid concerns about risks that come with crypto-asset price volatility, leverage, interconnectedness, operational risks, and compliance with laws and regulations, the Council emphasized on enforcing existing rules and regulations. They suggested legislation to regulate stablecoins and crypto-asset spot markets.

This FSOC report was published a week after the Office of the Comptroller of the Currency (OCC) commented on the emerging risk posed to the federal banking system by the use of AI in banking. According to the OCC, the widespread adoption of AI in banking could lead to issues regarding compliance risk, credit risk, reputational risk, and operational risk.