The Bank of England (BoE) published a paper that studies whether human or artificial intelligence is more conducive to a stable financial system. The study characterizes possibilities and challenges in designing partnerships that combine the strengths of both minds and machines. The insights derived from this are then leveraged to explain how the differences in human and artificial intelligence have driven the use of new techniques in financial markets, regulation, supervision, and policy making and to discuss their potential impact on financial stability. The paper also discusses how effective mind-machine partnerships might be able to reduce systemic risks.
While discussing how partnerships between human and artificial intelligence might operate in financial markets to reduce the risks of artificial intelligence applications, the paper focuses on applications in trading, portfolio management, and lending. The paper highlights that machine learning models may cut lending during a crisis, magnifying the downturn, whereas relationship banking protects customers from cutting back lending in response to a crisis and protects banks from runs during a crisis. However, the different strengths of human relationship lending and automated lending suggest that these two approaches should complement each other in a partnership of human and artificial intelligence. Similarly, the fundamental differences between human and artificial intelligence not only help to understand how applications of artificial intelligence affect financial stability risks in the financial market, but also in regulating and supervising the financial sector. A fully automated regulatory process based on machine-readable rules would bear great risks and human involvement is required to interpret legal requirements flexibly and to focus on the overarching goal of a stable financial system. Artificial intelligence tools can help to spot patterns and outliers in regulatory trends but bigger and more timely data does not necessarily make the financial system more stable.
With respect to the supervision in financial sector, the paper notes that artificial intelligence applications can be used for forecasting and systemic risk assessment and can help supervisors to work more efficiently and better discover risks buried in data. The paper, however, notes that trustworthiness is a major challenge for artificial intelligence systems as they do not know what is good and what is not and have no inherent values. This makes them prone to unethical behavior and the fact that artificial intelligence agents collude, or may discriminate, are examples of this. Regardless, several studies have shown that financial distress and failure of banks can be predicted using machine learning methods on the financial information of firms. Though humans cannot be expected to be much better at predicting shocks like COVID-19, their judgment is likely to be superior when responding to these extreme situations. Thus, artificial intelligence is very unlikely to replace regulators, supervisors, or policy makers in the near future, for reasons of robust decision-making in the face of uncertainty; however, these agencies/entities stand to profit from artificial intelligence tools that can assist them in making their decisions. Therefore, in an effective partnership, supervisors, regulators, and policy makers must not be threatened in their autonomy and should always be able to overrule an algorithmic assessment. Artificial intelligence can supplement, but is unlikely, any time soon, to supplant that information set and decision-making capacity.
Keywords: Europe, UK, Banking, Artificial Intelligence, Machine Learning, Systemic Risk, Financial Stability, Banking Supervision, Regtech, Fintech, Suptech, Lending, Big Data, BoE
Across 35 years in banking, Blake has gained deep insights into the inner working of this sector. Over the last two decades, Blake has been an Operating Committee member, leading teams and executing strategies in Credit and Enterprise Risk as well as Line of Business. His focus over this time has been primarily Commercial/Corporate with particular emphasis on CRE. Blake has spent most of his career with large and mid-size banks. Blake joined Moody’s Analytics in 2021 after leading the transformation of the credit approval and reporting process at a $25 billion bank.
The European Banking Authority (EBA) published its work program for 2023 as well as the technical package for phase 3 of version 3.2 of its reporting framework.
The Board of Governors of the Federal Reserve System (FED) announced a pilot climate scenario analysis exercise for six largest banks in the U.S.
The Bank for International Settlements (BIS) published a paper that studies impact of fintech lending on credit access for small businesses in U.S.
The Prudential Regulation Authority (PRA) issued the policy statement PS8/22 to amend the Own Funds and Eligible Liabilities (CRR) Part of the PRA Rulebook and update the supervisory statement SS7/13 titled "Definition of capital (CRR firms).
The European Banking Authority (EBA) launched the EU-wide transparency exercise for 2022, with results of the exercise expected to be published at the beginning of December, along with the annual Risk Assessment Report.
The Single Resolution Board (SRB) welcomed the adoption of the review of the Capital Requirements Regulation, or CRR, also known as the "CRR quick-fix."
The European Commission (EC) recently adopted the Delegated Regulation 2022/1622, which sets out the regulatory technical standards to specify the countries that constitute advanced economies for the purpose of specifying risk-weights for the sensitivities to equity.
The European Banking Authority (EBA) published the final draft regulatory technical standards specifying and, where relevant, calibrating the minimum performance-related triggers for simple.
The European Central Bank (ECB) is undertaking the integrated reporting framework (IReF) project to integrate statistical requirements for banks into a standardized reporting framework that would be applicable across the euro area and adopted by authorities in other EU member states.
The European Banking Authority (EBA) has been awarded the top European Standard for its environmental performance under the European Eco-Management and Audit Scheme (EMAS).