FSOC Identifies Use of AI as Vulnerability in Financial System

The Financial Stability Oversight Council (FSOC) has, for the first time, identified the use of artificial intelligence (AI) in financial services as a vulnerability in the financial system.

That is one of the potential emerging threats to U.S. financial stability identified by the FSOC in its 2023 annual report, the agency said in a Thursday (Dec. 14) press release.

While AI offers potential benefits such as cost reduction and improved efficiency, it also introduces risks such as cyber and model risks, according to the release. The Council recommended monitoring the rapid developments in AI and deepening expertise and capacity to identify emerging risks.

Another key recommendation in the report is related to the banking sector, the release said. The FSOC supports member agencies’ plans to review capital measures and improve resolvability at large, complex or interconnected banks. The Council also recommended close monitoring of uninsured deposit levels and depositor composition, as well as the collection of additional data as necessary.

Cybersecurity is another area of focus highlighted in the report, per the release.

The FSOC recognized that cybersecurity risk is pervasive throughout the economy, particularly within the financial system. The Council recommended ongoing partnerships between state and federal agencies, private firms and international efforts to promote information sharing and mitigate cyber-related financial stability risks.

The report also addressed the evolving participation of non-bank financial institutions in the provision of financial services, according to the release.

The FSOC highlighted the importance of monitoring vulnerabilities and potential risks to the broader financial system, particularly in areas such as nonbank mortgage servicers and private credit. The Council said it supports efforts by regulatory agencies to address risks associated with investment funds and encourages data collection improvements and engagement regarding potential reforms.

Climate-related financial risk is another significant concern highlighted in the report, the release said. The FSOC acknowledged the increasing costs imposed by severe and frequent climate-related events and emphasized a need for enhanced coordination of data and risk assessment. Financial regulators are encouraged to promote consistent and informative disclosures that allow investors and financial institutions to consider climate-related financial risks.

Lastly, the report addressed financial stability vulnerabilities related to digital assets, per the release. The FSOC highlighted the risks associated with crypto-asset price volatility, leverage, interconnectedness, operational risks and compliance with laws and regulations. The Council emphasized the importance of enforcing existing rules and regulations, recommending legislation to regulate stablecoins and the spot market for crypto-assets.

This report comes about a week after the Office of the Comptroller of the Currency (OCC) said that the use of AI in banking is an emerging risk faced by the federal banking system.

Widespread adoption of AI in banking may present challenges related to compliance risk, credit risk, reputation risk and operational risk, the OCC said on Dec. 7.

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