US to Scrutinize AI’s Impact on Financial Stability, Yellen Announces

In response to growing concerns about the systemic risks posed by artificial intelligence (AI) in the financial sector, US Treasury Secretary Janet Yellen has announced that top US regulators will prioritize examining AI’s potential threats in 2024. This initiative aligns with President Joe Biden’s executive order from October, aimed at establishing security and privacy standards for AI technology.

During a Financial Stability Oversight Council (FSOC) meeting, which includes leaders from the Federal Reserve and the Securities and Exchange Commission (SEC), Yellen emphasized the need to monitor emerging technologies and associated risks. The FSOC, established after the 2008 financial crisis, has identified AI usage in financial services as a key vulnerability.

Yellen acknowledged that while AI could bring benefits like increased efficiency to the financial system, it’s crucial to apply existing risk management principles and rules. Wall Street has been increasingly integrating AI, hiring data engineers and quantitative analysts, which has prompted caution from regulators such as SEC Chair Gary Gensler and the Fed’s Michael Barr.

The FSOC’s annual report highlighted several risks AI might introduce or exacerbate in financial institutions. One significant concern is AI’s potential for discriminatory bias in lending decisions, particularly for AI programs that are “black boxes” with outputs that are difficult to explain. The report expressed concern over AI systems potentially producing biased or inaccurate results that could affect consumer protection aspects like fair lending.

While the report brings new attention to AI, it stops short of offering specific regulatory proposals, instead suggesting that financial institutions and regulatory authorities build expertise to monitor AI and identify emerging risks.

Yellen also pointed out other risks to financial stability, such as high interest rates impacting real estate, climate change, cyber threats, and increasing leverage in certain financial sectors, including hedge funds. The FSOC report examined the role of leveraged hedge funds in the March 2020 US Treasury market liquidity crisis and noted ongoing considerations for policy options to address this vulnerability.

Reflecting on 2023, including bank failures that impacted the banking sector, Yellen stated that while financial firms generally remain sound, ongoing vigilance is necessary. She highlighted the swift response by FSOC member agencies to the recent bank failures to prevent wider contagion and maintain confidence in the banking system.

The FSOC report also reviewed the March banking episode, focusing on lessons learned and emphasizing the need for banking regulators to monitor uninsured deposit levels. However, it did not propose specific measures to address the accelerated pace of modern bank runs.

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