Artificial intelligence (AI) models come with a unique and powerful combination of features: they learn and evolve autonomously and at speed, based on a broad range of data, with outputs that aren’t always interpretable or explainable and objectives that may be neither completely clear nor aligned with society’s goals, said Sarah Breeden, deputy governor for Financial Stability of the Bank of England, in a recent speech.
Along with cyber implications and over-reliance on a few third-party providers for deployment, there are other channels through which AI can have systemic risk consequences, particularly if they come to be used more in trading. For example, AI could lead to increased market speed and volatility under stress.
Specifically, multiple market participants using the same AI models and relying on a small number of AI service providers for trading could result in increasingly correlated trading behavior. Particularly where such crowded trades are funded through leverage, a shock which causes losses for such trading strategies could be amplified into more serious market stress through feedback loops of forced selling and adverse price moves.
Indeed, some AI trading models might respond to such a scenario by seeking to exploit vulnerabilities in the trading algorithms and strategies of other firms in a manner which is individually rational but has adverse consequences for the overall financial system, by triggering or amplifying price movements in a manner which is destabilizing for financial stability.
There is also the potential for system-wide conduct risk. If AI determines outcomes and makes decisions, what would be the consequences if, after a few years, such outcomes and decisions were legally challenged, with mass redress needed?
Even experts don’t agree on how far and how fast AI (including in finance) will evolve. So we need both to be humble and to be prepared. While not jumping to knee-jerk policy responses, we need to keep under review whether our microprudential and macroprudential policies remain sufficient to maintain financial stability. In so doing, we can harness AI’s considerable benefits for economic growth in a safe and sustainable way.