The changing financial institution landscape due to generative artificial intelligence (GenAI) should be approached with “agility and flexibility” by regulators, the outgoing top supervisor at the Federal Reserve said Tuesday.
Michael Barr, the Federal Reserve Board vice chair for supervision (who has announced his resignation from that role once a successor is confirmed by the Senate) also said, regarding GenAI, that financial institutions, along with the Fed, “should consider investing sufficient resources in understanding GenAI technology, incorporating it into their workflows where appropriate, and training staff on how to use the technology responsibly and effectively.”
Beyond the financial sector, Barr asserted, collaboration among governments, private industry, and research institutions “will be critical” to ensure that “GenAI systems are not weaponized in catastrophic ways.”
Barr defined GenAI as subset of AI “that has seen significant growth and integration into economic activity in just a few short years.” He said GenAI can generate content, allowing the technology to “significantly enhance productivity across a range of knowledge-based activities and be used by people without coding skills.” He predicted that GenAI will become a “general purpose technology,” with widespread adoption, continuous improvement, and productivity enhancements to a wide range of sectors across the economy. “We are already seeing GenAI improve the productivity of its own R&D,” he said.
“We should continue to focus on responsible AI research and development and implement safeguards against misuse, including monitoring systems, standards for secure AI system development, and agreement on red lines for acceptable use cases,” Barr said. “We should be attuned to the impact of GenAI on our economic and political institutions. There’s a risk that it concentrates economic and political power in the hands of the very few and could lead to the gains being realized only by a small group, while the rest are left behind.”
Barr also contended that GenAI’s goal should be to enhance, not replace, humans. He advocated establishing best practices and cultural norms to that end.
“Every financial institution should recognize the limitations of the technology, explore where and when GenAI belongs in any process, and identify how humans can be best positioned to be in the loop,” he said. “We should also focus on data quality, and make sure that uses of GenAI do not perpetuate or amplify biases inherent in the data used to train the system or make incorrect inferences to the extent the data is incomplete or nonrepresentative.””
He further warned of the risk in finance, arguing that the attributes that the speed, automaticity, and ability to optimize financial strategies that makes GenAI also present risk.
“When the technology becomes ubiquitous, use of GenAI could lead to herding behavior and the concentration of risk, potentially amplifying market volatility,” Barr said. “As GenAI agents will be directed to maximize profit, they may converge on strategies to maximize returns through coordinated market manipulation, potentially fueling asset bubbles and crashes. Speed, automaticity, and ubiquity could generate new risks at wide scale.”
Finally, he suggested monitoring how introduction of GenAI changes the banking landscape. “Nonbanks may be more nimble and risk-forward in incorporating GenAI into their operations, which may push intermediation to less-regulated, less transparent corners of the financial sector. In addition, this competitive pressure may push all institutions, including regulated institutions, to take a more aggressive approach to GenAI adoption, heightening the governance, alignment, and financial risks I mentioned before,” Barr said.
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