This semi-monthly column highlights news, government documents, NGO/IGO papers, conferences, industry white papers and reports, academic papers and speeches, and central bank actions on the subject of AI’s fast paced impact on the banking and finance sectors. The chronological links provided are to the primary sources, and as available, indicate links to alternate free versions.

NEWS:

Fed Oversight Council Argues for More Control Over FinTech. Payments, December 6, 2024. The Financial Stability Oversight Council (FSOC) said Friday (Dec. 6) that Congress should pass legislation ensuring that relevant agencies have the examination and enforcement powers they need to oversee their regulated entities’ third-party service providers. The FSOC said these relevant agencies include the Federal Housing Finance Agency and the National Credit Union Administration, according to a Friday press release announcing the council’s approval of its 2024 annual report. It also recommended that federal banking regulators continue to support information sharing among state and federal regulators by coordinating third-party service provider examinations, working collaboratively with states and identifying additional ways to do so.  “Financial institutions are increasingly using third parties to provide a range of products and services,” the release said. “While third-party service providers can offer benefits, they may also introduce or amplify risks, in part by limiting a financial institution’s access to, control over, and oversight of its data or systems.” The increasing use of third-party service providers is one of several vulnerabilities and emerging threats to U.S. financial stability that the FSOC identified in its annual report. It also pointed to the increasing frequency of cyber incidents, the weakening credit conditions in commercial real estate (CRE), the reliance of some banks on non-deposit funding and uninsured funding, the growing market value of the crypto-asset ecosystem and the financial vulnerabilities stemming from investment funds. “This year, the financial system has continued to support a strong economy, marked by declining inflation, solid economic growth and a healthy labor market,” Secretary of the Treasury Janet L. Yellen said in the release. “But we must remain focused on ensuring the financial system remains resilient and addressing emerging vulnerabilities.” This announcement came a day after it was reported that the Federal Deposit Insurance Corporation (FDIC) has begun more closely tracking FinTechs that partner with banks, aiming to spot potential problems before they affect the banks. It also follows a Nov. 20 statement by Acting Comptroller of the Currency Michael J. Hsu supporting “federal payments regulation and a chartering regime for nonbanks.” Hsu said that if FinTechs remain licensed and regulated only at the state level, some of them are likely to exploit any regulatory gaps.

Bosses struggle to police workers’ use of AI. Staff are adopting large language models faster than companies can issue guidelines on how to do so. Financial Times. December 15, 2024. Employers have been scrambling to keep up as workers adopt generative AI at a much faster pace than corporate policies are written. An August survey by the Federal Reserve Bank of St Louis found nearly a quarter of the US workforce was already using the technology weekly, rising closer to 50 per cent in the software and financial industries. Most of these users were turning to tools such as ChatGPT to help with writing and research, often as an alternative to Google, as well as using it as a translation tool or coding assistant. But researchers warn that much of this early adoption has been happening in the shadows, as workers chart their own paths in the absence of clear corporate guidelines, comprehensive training or cyber security protection. By September, almost two years after the launch of ChatGPT, fewer than half of executives surveyed by US employment law firm Littler said their organisations had brought in rules on how employees should use generative AI. Among the minority that have implemented a specific policy, many employers’ first impulse was to jump to a blanket ban. Companies including Apple, Samsung, Goldman Sachs, and Bank of America prohibited employees from using ChatGPT in 2023, according to Fortune, primarily due to data privacy concerns. But as AI models have become more popular and more powerful, and are increasingly seen as key to staying competitive in crowded industries, business leaders are becoming convinced that such prohibitive policies are not a sustainable solution.

Wall Street’s AI-powered rally risks ‘correction’, Vanguard warns. Financial Times, December 3, 2024. Investors’ rush into artificial intelligence stocks this year has overplayed the near-term potential of the technology, raising the risks of a “correction” in share prices, asset management powerhouse Vanguard has warned. Joe Davis, Vanguard’s chief economist, said investors have gone too far in their bets on AI’s potential, even if the technology proves to have similar effects to the personal computer, whose adoption since the 1980s revolutionised productivity and jobs. The cautious remarks from the world’s second-largest asset manager add to the fierce debate among investors over whether groups that rode the AI wave are overvalued after huge gains in recent months. “We see roughly 60 to 65 per cent odds that AI is more impactful than the personal computer. The US stock market today is pricing roughly a 90 per cent probability,” said Davis, who leads the $10tn asset manager’s investment strategy group. Productivity gains from PCs, and optimism about their potential helped fuel a powerful surge in equities prices in the second half of the late 1990s that culminated in the dotcom bubble bursting in 2000.

The Economics of Artificial Intelligence — What Does Automation Mean for Workers? Despite tremendous progress in AI, the economic implications of AI remain inadequately understood, with unsatisfactory insights from AI practitioners and economists. Medium Towards Data Science. November 25, 2024. The pace of AI advancements is unprecedented, with significant improvements in both model capabilities and cost efficiency. However, the economic implications of AI remain inadequately understood, with unsatisfactory insights from AI practitioners, economists and think-tanks. Economists often underestimate AI’s potential impact due to limited engagement with cutting-edge developments.

PAPERS – NGO/IGOs

Bank for International Settlement (BIS). Regulating AI in the financial sector: recent developments and main challenges, FSI Insights | No 63  | 12 December 2024 by Juan Carlos Crisanto, Cris Benson Leuterio, Jermy Prenio and Jeffery Yong. This paper explores the potential transformative impact of artificial intelligence (AI) on the financial sector, focusing on operational efficiency, risk management and customer experience in banking and insurance. It delves into the widespread adoption of AI technologies including generative AI (gen AI) and examines the associated risks and regulatory implications. While AI exacerbates existing risks such as model risk and data privacy, it does not introduce fundamentally new risks apart from gen AI, which may give rise to hallucination and anthropomorphism risks. Most financial authorities have not issued AI regulations specific to financial institutions as existing frameworks already address most of these risks. Nevertheless, some areas require further regulatory attention, including governance, expertise and skills, model risk management, data governance, non-traditional players in the financial sector, new business models and third-party AI service providers.

Bank for International Settlement (BIS). Large language models: a primer for economists, BIS Quarterly Review | 10 December 2024 by Byeungchun Kwon, Taejin Park, Fernando Perez-Cruz and Phurichai Rungcharoenkitkul. Large language models (LLMs) are powerful tools for analysing textual data, with substantial untapped potential in economic and central banking applications. Vast archives of text, including policy statements, financial reports and news, offer rich opportunities for analysis. This special feature provides an accessible introduction to LLMs aimed at economists and offers applied researchers a practical walkthrough of their use. We provide a step-by-step guide on the use of LLMs covering data organisation, signal extraction, quantitative analysis and output evaluation. As an illustration, we apply the framework to analyse perceived drivers of stock market dynamics based on over 60,000 news articles between 2021 and 2023. While macroeconomic and monetary policy news are important, market sentiment also exerts substantial influence.

Bank for International Settlement (BIS). Generative artificial intelligence and cyber security in central banking. BIS Papers | No 145 | 23 May 2024 by Iñaki Aldasoro, Sebastian Doerr, Leonardo Gambacorta, Sukhvir Notra, Tommaso Oliviero and David Whyte. Generative artificial intelligence (gen AI) introduces novel opportunities to strengthen central banks’ cyber security but also presents new risks. We use data from a unique survey among cyber security experts at major central banks to shed light on these issues. Responses reveal that most central banks have already adopted or plan to adopt gen AI tools in the context of cyber security, as perceived benefits outweigh risks. Experts foresee that AI tools will improve cyber threat detection and reduce response time to cyber attacks. Yet gen AI also increases the risks of social engineering attacks and unauthorised data disclosure. To mitigate these risks and harness the benefits of gen AI, central banks anticipate a need for substantial investments in human capital, especially in staff with expertise in both cyber security and AI programming. Finally, while respondents expect gen AI to automate various tasks, they also expect it to support human experts in other roles, such as oversight of AI models.

Federal Reserve Bank of New York. September 4, 2024. AI and the Labor Market: Will Firms Hire, Fire, or Retrain? Jaison R. Abel, Richard Deitz, Natalia Emanuel, and Benjamin Hyman. Decorative Image: Engineers programming automated robot during checking the robot coding. The rapid rise in Artificial Intelligence (AI) has the potential to dramatically change the labor market, and indeed possibly even the nature of work itself. However, how firms are adjusting their workforces to accommodate this emerging technology is not yet clear. Our August regional business surveys asked manufacturing and service firms special topical questions about their use of AI, and how it is changing their workforces. Most firms that report expected AI use in the next six months plan to retrain their workforces, with far fewer reporting adjustments to planned headcounts. Among businesses using AI over the past six months, 10 percent of service firms had reduced worker counts in response to AI and 5 percent had increased them, while no manufacturers had made such changes. Among those planning to use AI over the next six months, firms expect to hire more workers than fire workers to accommodate its use, and about half plan to retrain current staff to use it. These results are consistent with economic arguments than downplay alarmism about AI’s potential to displace workers and instead point to its potential to augment employment and fill labor shortages.

PAPERS:

Harvard Business Review. Research: How Gen AI Is Already Impacting the Labor Market. November 11, 2024. In the early 2000s, when Amazon introduced its Kiva robots to automate warehouse operations, employees feared for their jobs as machines began taking over tasks previously performed by humans. Today, advances in gen AI and natural language processing, such as ChatGPT, are transforming many industries and raising similar concerns. However, unlike past automation technologies, gen AI has the unique potential to impact all job sectors, particularly given its fundamental ability to improve its capabilities over time — which promises to affect the workforce in ways that go beyond simple job replacement. In new research, forthcoming in Management Science, we explore the impact gen AI has already had on the labor market by examining trends in demand for online freelancers. Our findings show significant short-term job replacement after these tools were introduced, and that jobs prone to automation, like writing and coding, were the most affected by ChatGPT. Our research also examines how competition, job requirements, and employer willingness-to-pay have changed to better understand how the online job market is evolving with the rise of gen AI. Although still in its early stages, gen AI’s impact on online labor markets is already becoming discernible, suggesting potential shifts in long-term labor market dynamics that could bring both challenges and opportunities.