Yellen Warns AI Could Pose ‘Significant Risks’ to Financial System

Secretary of the Treasury Janet Yellen speaks in New York on Sept. 20, 2023. (Julia Nikhinson/AP Photo)

While artificial intelligence (AI) could present new opportunities and deliver vast riches to the financial system, the technology could pose “significant risks,” according to Treasury Secretary Janet Yellen.

At an event co-hosted by the Brookings Institution and the Financial Stability Oversight Council, Ms. Yellen outlined various vulnerabilities that AI presents to the financial sector.

Some of these threats involve “insufficient or faulty data,” the concentration of vendors providing cloud and data services, “inadequate” risk management practices, and the overall intricacies of AI models.

At the same time, Ms. Yellen identified that AI, from image recognition to generative AI, could help investors better manage their portfolios and support forecasting models. The technology, she noted, can help banks combat fraud, enhance their customer service, lower service costs, and improve client access.

She confirmed that “Treasury is launching a formal public request for information to seek comments from financial institutions, consumers, advocates, academics, and other stakeholders on the current uses, opportunities, and risks of AI in the financial services sector.”

“Given how quickly AI technology is developing, with fast-evolving potential use cases for financial firms and market participants, scenario analysis could help regulators and firms identify potential future vulnerabilities and inform what we can do to enhance resilience,” Ms. Yellen said.

“The tremendous opportunities and significant risks [connected to the utilization of AI by financial firms have] moved this issue toward the top of Treasury’s and the Financial Stability Oversight Council’s agendas.”

Other U.S. and worldwide officials have expressed similar concerns about AI’s threat to the financial system.

World Is Watching

Earlier this year, Securities and Exchange Commission (SEC) Chair Gary Gensler warned that centralized AI could result in a “pretty fragile” financial system, as thousands of financial players rely on central data or a single platform.

Should the “monoculture” get it wrong, “there is a risk in this society and the financial sector at large,” Mr. Gensler told an event hosted by nonprofit consumer rights advocacy group Public Citizen.

The Wall Street watchdog also told a December 2023 conference hosted by The Messenger that financial markets need to refrain from engaging in an “AI-wash” mentality by overhyping, overpromising, and misleading the technology.

Additionally, in an October 2023 interview with the Financial Times, the SEC chief asserted that it’s “nearly unavoidable” that AI would trigger a financial crisis within a decade.

“I do think we will in the future have a financial crisis,” he told the newspaper. “In the after-action reports, people will say ‘Aha! There was either one data aggregator or one model we’ve relied on.’ Maybe it’s in the mortgage market. Maybe it’s in some sector of the equity market.”

Treasury Secretary Janet Yellen looks on as Securities and Exchange Commission Chairman Gary Gensler speaks during a meeting of the Financial Stability Oversight Council at the Department of Treasury in Washington on Dec. 14, 2023. (Drew Angerer/Getty Images)

European Central Bank economists shared similar concerns as the SEC chief. They published a May paper for the Financial Stability Review, arguing that an “overreliance and a limited number of AI suppliers” would create a “more fragile” financial system.

“AI may thus contribute to a further shift in market power amid an increasingly digitalised environment, leading to a higher concentration in the financial system, among either existing players or new players,” the paper reads, noting that this could produce “too-big-to-fail externalities.”

According to International Monetary Fund Deputy Managing Director Gita Gopinath, AI could exacerbate the next economic downturn because it “is likely to threaten a wider range of jobs than in past cycles, including higher-skilled cognitive jobs.”

This event, which could present “a major shock” to the financial system, might occur in both advanced economies and emerging markets, Ms. Gopinath noted.

“But unless policymakers understand how AI impacts the economy, they could be ‘flying blind’ in the next recession,” she said at a Swiss summit on May 30.

Banks Bullish on AI

The financial sector is embracing the technology despite the risks that artificial intelligence and automation present, according to a new study.

The IBM Institute for Business Value revealed findings from a new report that found two-thirds of banking and financial markets CEOs believe that the productivity gains from AI are so immense that they must accept the risks to maintain a competitive advantage.

The survey also found that 65 percent of business leaders think AI success will depend on the public’s adoption, and 60 percent are pushing for greater AI adoption faster.

This might be a roadblock as a recent NORC survey discovered that just 4 percent of young Americans aged 14 to 22 are regularly using generative AI.

Meanwhile, another notable concern among the study participants is finding the right talent to help companies scale AI.

While half are hiring for generative AI roles, 53 percent concede that they struggle to fill them.

“Our research reflects the tremendous pressure CEOs are under to keep their competitive edge. Alongside profitability and productivity, getting the right skills remains a persistent challenge, with CEOs now hiring for roles that did not exist until recently,” Shanker Ramamurthy, global managing partner of banking and financial markets at IBM Consulting, said in a statement.

“Workforce needs are shifting rapidly in the financial services sector and CEOs must ensure that upskilling programs are prioritized as an important element of any financial institution’s enterprise strategy for scaling generative AI.”