FSOC Flags AI Risks for Financial Stability

The Financial Stability Oversight Council (FSOC) has sounded a cautionary note in its 2023 annual report, identifying the rapid adoption of artificial intelligence (AI) as an emerging vulnerability in the U.S. financial system. The council, chaired by Treasury Secretary Janet Yellen, emphasized the potential benefits of AI, including cost reduction and improved efficiency, but underscored the need for vigilance as the technology introduces new risks that could compromise financial stability.

The report, released on December 14, marks the first time that the FSOC has highlighted AI as a potential threat. The council acknowledged the positive impact AI could have on financial firms, particularly in terms of innovation and efficiency. However, it also warned of specific risks, including cyber threats and model risks associated with the opaque nature of some AI tools.

The FSOC urged financial institutions and regulators to enhance their expertise and monitoring capabilities to keep pace with the evolving landscape of AI innovation. The use of AI tools, some of which rely on large external datasets and third-party vendors, brings forth privacy and cybersecurity concerns. The council stressed the importance of understanding these tools thoroughly to avoid biased or inaccurate results, emphasizing that the complexity of some AI models could make it challenging for companies and regulators to identify shortcomings.

Regulators, including the Securities and Exchange Commission (SEC), are already scrutinizing how firms utilize AI. The White House has also taken steps to address AI risks, with President Joe Biden signing an executive order in October aimed at establishing standards for safety testing foundational AI models.

The FSOC’s report highlighted the increasing role of nonbanks and private credit, urging heightened attention from financial institutions and regulators. The growing risks associated with climate change were also emphasized, with the council recommending coordinated efforts to enhance data and risk assessment related to climate-related financial risks.

The report came on the heels of the Office of the Comptroller of the Currency’s (OCC) acknowledgment that AI in banking poses emerging risks to the federal banking system. The OCC, in its December 7 statement, pointed out potential challenges related to compliance, credit, reputation, and operational risks arising from the widespread adoption of AI in the banking sector.

Treasury Secretary Janet Yellen, speaking on behalf of the FSOC, outlined the council’s commitment to monitoring evolving technologies and associated risks in 2024. She emphasized the need for responsible innovation while adhering to existing principles and rules for risk management.