BoE Paper Studies Impact of Mind-Machine Partnerships on Systemic Risk
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.
Previous ArticleDubai FSA Updates Rulebook Modules for Banks in August 2021
BOE Sets Out Its Thinking on Regulatory Capital and Climate Risks
The Bank of England (BOE) published a working paper that aims to understand the climate-related disclosures of UK financial institutions.
OSFI Finalizes on Climate Risk Guideline, Issues Other Updates
The Office of the Superintendent of Financial Institutions (OSFI) is seeking comments, until May 31, 2023, on the draft guideline on culture and behavior risk, with final guideline expected by the end of 2023.
BIS Paper Examines Impact of Greenhouse Gas Emissions on Lending
BIS issued a paper that investigates the effect of the greenhouse gas, or GHG, emissions of firms on bank loans using bank–firm matched data of Japanese listed firms from 2006 to 2018.
HMT Mulls Alignment of Ring-Fencing and Resolution Regimes for Banks
The HM Treasury (HMT) is seeking evidence, until May 07, 2023, on practicalities of aligning the ring-fencing and the banking resolution regimes for banks.
BCBS Report Examines Impact of Basel III Framework for Banks
The Basel Committee on Banking Supervision (BCBS) published results of the Basel III monitoring exercise based on the June 30, 2022 data.
PRA Consults on Prudential Rules for "Simpler-Regime" Firms
Among the recent regulatory updates from UK authorities, a key development is the first-phase consultation, from the Prudential Regulation Authority (PRA), on simplifications to the prudential framework that would apply to the simpler-regime firms.
DNB Publishes Multiple Reporting Updates for Banks
DNB, the central bank of Netherlands, updated the list of additional reporting requests and published additional data quality checks and XBRL-Formula linkbase documents for the first quarter of 2023.
NBB Sets Out Climate Risk Expectations, Issues Reporting Updates
The National Bank of Belgium (NBB) published a communication on climate-related and environmental risks, issued an update on XBRL reporting
EBA Updates Address Securitization Standards and DGS Guidelines
The European Banking Authority (EBA) published the final draft of the regulatory technical standards that set out conditions for assessment of homogeneity of the underlying exposures in simple, transparent, and standardized (STS) securitizations.
FSB Publishes Letter to G20, Sets Out Work Priorities for 2023
The Financial Stability Board (FSB) published a letter intended for the G20 Finance Ministers and Central Bank Governors, highlighting the work that FSB will take forward under the Indian G20 Presidency in 2023