While artificial intelligence is changing financial markets globally at a great rate, new risks to stability of financial markets can be created, warning has been issued by the IMF. With increasing reliance of finance and investment firms, banks and other institutions on AI tools for automated trading, lending and transaction monitoring and fraud detection, a need to increase the watchfulness, before systemic financial risks emerge from vulnerabilities created.
The IMF has warned that financial risks posed by AI technology may be amplified by faster decision making due to reliance on communal digital frameworks and sophisticated cyber threats and that use of artificial intelligence technologies, even, generative AI, should now include increasingly autonomous functions in banking and investment operations throughout.
AI is More Than a Driver of Efficiency Today
Tobias Adrian, the International Monetary Fund’s Financial Counsellor and Director, Monetary and Capital Markets Department, explained that AI can no longer be viewed just as a tool for efficiency in financial markets. It has begun to be deeply integrated into transactions of trading, lending, in support structures of the markets and in regulatory oversight mechanisms. Such reliance brings significant potential for disruption within financial sector and a failure within the AI system will have consequences well beyond the individual company, as it will have an impact on several institutions due to reliance on fewer providers for cloud technology and AI services. Thus, failure in providing the support service by technology provider or cyber-attack/operational breakdown, would have ramifications across the whole financial sector simultaneously.
Cyber-Attacks May Grow at Unprecedented Speed
The growing link between artificial intelligence and the field of cybersecurity presents another major worry for the financial world. While banks and financial institutions may have been the beneficiaries of new fraud detection systems and the ability to identify online intrusions much faster with the application of AI to their processes, criminals may use the same technology to gain access through much more sophisticated and automated attacks. Cyber criminals may now, be able to obtain knowledge of flaws and loopholes within financial sector’s systems more readily thus speeding up spread of cyber-attacks to the financial sector, that far exceed the capacity of the finance world to adequately combat these trends. Extremely disruptive cyber incidents have been flagged for potentially leading to severe funding pressures and solvency concerns for banks and financial institutions and ultimately to global market disruption and the complex nature of the technology makes it more challenging for the regulators to navigate.
Market Volatility and Correlated Action May Result from Common AI Models
Another worry lies in dependence on common systems and algorithms. If many banks, investment managers and traders run on similar AI models with the same operational parameters and decision making algorithms, their responses to events in the markets may prove identical. This can lead to common correlated behavior even during events of financial stress, as systems, guided by the same algorithms and inputs, may simultaneously respond by shifting asset exposure or increasing or decreasing credit risk.
Such coordinated buying or selling by multiple entities relying on similar AI, could trigger significant market movements.
As AI operating systems function at speeds beyond human capability and with automated parameters, there may only be limited opportunity to manage volatility at this speed of operation.
Call for Stronger Central Bank Vigilance by the IMF
Given these potential risks, The International Monetary Fund is calling for greater scrutiny from central banks and financial supervisors as use of AI becomes ubiquitous in all spheres of finance. Regulators will likely need improved systems for monitoring AI-related dangers in the banking and non-bank financial institutions, the role AI is playing in operations and understanding dependencies on technology providers; systems must be put in place to manage risk efficiently. Transparency is likely to be the order of the day as finance and investment institutions become more knowledgeable about how the algorithms and the underlying code determine credit risk decisions, investment parameters and their overall portfolio risk exposures.
Human oversight remains crucial in finance operations despite advances in technology. While it is true that AI can compute huge amounts of data and find correlations more swiftly than human operators do, it can also commit errors, perpetuate biases and behave in unexpected ways in times of atypical conditions. Trusting completely on automated operations is deemed risky for crucial financial operations.
Strong governance models of operation in conjunction with robust security measures, independent audits, and a system of human interaction and intervention is perceived to be a necessary factor for the finance industry.
The Financial Stability Board also emphasized the need to adopt best practices in using AI at financial institutions, including appropriate human controls.
Challenge of AI in India
Given the accelerated pace of adopting digital finance services and expansion of AI application within the Indian financial market: Indian Banks are utilizing AI systems at all levels from fraud detection, loan approval to client assistance and risk management; it is clear that The International Monetary Fund’s report is highly pertinent for the developing financial landscape in the country. While innovation in terms of efficiency, and a move towards financial access is beneficial; a reliance on a broad range of electronic platforms brings new concerns about data privacy and cybersecurity within the banking and non-banking financial institutions and it poses an issue for regulators to manage risks arising as they provide incentives for digital expansion.
The Future of AI in Finance
AI technology is expected to continue evolving and influencing the financial markets over many years; and that the impact is on better credit decisions, sophisticated security measures, advanced planning and increasing access to information and services for financial market stakeholders globally. However, the report issued by The International Monetary Fund reminds all to weigh the rewards of AI against its inherent threats, given its potential ability to amplify disruptions and spread risk between entities within the financial system, due to dependence on common platforms. The core message to the policy world from the IMF, is that The International Monetary Fund strongly argues that central banks and financial supervisors need to be proactively moving in sync with technology advancements to make sure artificial intelligence remains a force for efficiency, and innovation for the financial world.
