Artificial Intelligence in Finance Brings Risks to Stability

Banks and hedge funds that rely on artificial intelligence threaten to inject risks into the financial system that could exacerbate a future crisis, according to global regulators.

The financial industry's rush to adopt AI raises the potential that firms will become overly dependent on technologies that herd them toward the same view of risks and could “amplify financial shocks”, according to a study published by the Financial Stability Board, a panel of regulators that includes the Federal Reserve and European Central Bank, Tribelive.com reported.

“AI and machine learning applications show substantial promise if their specific risks are properly managed,” the FSB said in a report that called for additional monitoring and testing of robotic technologies designed to lessen human involvement. “Taken as a group, universal banks' vulnerability to systemic shocks may grow if they increasingly depend on similar algorithms or data streams.”

The FSB, headed by Bank of England Governor Mark Carney, said that many of the technologies are being designed and tested in a period of low volatility in financial markets, and, as a result, “may not suggest optimal actions in a significant economic downturn or in a financial crisis.”

Artificial intelligence is a branch of computer science that aims to imbue machines with aspects of reasoning. The term now includes machine learning, which is the ability for computers to learn by ingesting data, and natural language processing—the ability to read or produce text.

Embracing Tools

The world's biggest banks and hedge funds are embracing the tools, driven by the availability of major new sources of data that can be analyzed quickly with computer power and at the same time a desire to cut costs and employment levels. Management consultant Opimas estimated in March that AI would result in a cut of 230,000 workers at financial firms worldwide by 2025, with the hardest hit being 90,000 people in asset management.

Firms are using AI and machine learning to assess the credit quality of borrowers, price insurance contracts, automate interactions with clients and estimate the risk of trading positions, the FSB said. Hedge funds relying purely on AI and machine learning technologies are growing rapidly and have about $10 billion in assets under management, the FSB said, citing an estimate from an unnamed financial firm.

The FSB said technology's potential to cut costs and drive new profits is even creating an “arms race” among firms to demonstrate their use of AI.

In the process, firms may be relying on a small number of third-party technological developers and services. If those were to fail, the effect would ripple across the wider financial system and contribute to major disruptions at large financial firms at the same time.

“These risks may become more important in the future if AI and machine learning are used for 'mission-critical' applications of financial institutions,” the FSB said. “Moreover, advanced optimization techniques and predictable patterns in the behavior of automated trading strategies could be used by insiders or by cyber-criminals to manipulate market prices.”

Companies rushing to adopt AI risk being caught up in an “arms race”, the report says, as “market participants increasingly find it necessary to keep up with their competitors’ adoption of AI and machine learning, including for reputational reasons (hype).”

However, the potential benefits of AI and machine learning to the financial sector are believed to be considerable, allowing companies to process information more quickly and improve customer interactions—delivering swifter credit decisions, for example.

A Primary Way for Lenders

A separate report published by giant consultancy Accenture earlier this year found that three quarters of bankers believe AI will become the primary way lenders interact with their customers in the next three years.

AI could also improve regulatory compliance, the FSB said. The market for technology in regulation, known as RegTech, is forecast to reach $6.45 billion by 2020, the report said, with an eye-watering growth rate of 76% per year.

Furthermore, AI could create “new and unexpected forms of interconnectedness”, the report said, by tapping institutions’ previously unrelated data sources.

Regulators themselves can benefit from AI, with the FSB citing its potential to improve macro-prudential surveillance, as well as the detection of fraud and money laundering.