The evolution and adoption of AI (Artificial Intelligence) by the financial industry pose several risks to financial stability, cautioned the Financial Stability Report. The risks include interconnectedness becoming enhanced through over-reliance on shared technology, service providers and infrastructure.

In particular, there is a high risk of market concentration both within the financial industry as well as critical third party service providers of cloud and AI services.

Further, the threat of cyber risk turning into a financial stability risk is high as AI could aid cyber attackers through sophisticated phishing attacks such as creation of deepfakes using generative AI.

“With widespread availability of AI services such as ChatGPT, there has been a growing concern that these services are being used for cyberattacks,” per the Report, which is a half-yearly publication, with contributions from all financial sector regulators.

AI in capital markets

The report referred to IMF’s observations that the increased adoption of AI in capital markets can create additional risks related to increased market speed and volatility under stress, especially when trading strategies using AI become highly correlated.

Specifically, if such trades are funded through leverage, any shock could amplify market stress through fire sales and feedback loops.

Moreover, AI may encourage migration of more activities to NBFIs (non-banking financial institutions), increasing systemic opacity, per IMF.

The FSR, referring to the European Central Bank’s “Financial Stability Review, cautioned that if technological penetration and market and vendor concentration are high, transition of risk from individual firms to the financial system could be non-linear and portend systemic risk.

The report noted that standard setting bodies and national regulators and supervisors should, therefore, take a balanced approach to reap the benefits of AI while safeguarding the financial system.

They must update their skills and tools as well as proactively adapt their frameworks to identify and mitigate emerging risks from this rapidly evolving technology, it added.