November 02, 2017

Systemic risks in the financial sector keep growing. Yesterday risk weighted capital requirements and credit rating agencies. Today artificial intelligence

I refer to Izabella Kaminska’s discussion of a report published by FSB on the financial stability implications of artificial intelligence and machine learning in financial services. “When AI becomes too big to fail”, FT Alphaville, November 1 

1: “This warrants a societal discussion on the desired extent of risk sharing, how the algorithms are conceived, and which information are admissible.”

That is a discussion that should also have taken place before regulators, with their risk weighted capital requirements, created incentives for our banks, one societal prime risk-takers, to avoid all what is perceived as risky, like SMEs and entrepreneurs, and concentrate exclusively on what is perceived, decreed or concocted as safe. 

2:“Fintech and AI are being aggressively marketed as our best and only opportunity to diminish the concentrated power of the banks. The terms “new entrants”, “disruption”, “fragmentation” and “open access” form the foundations of the movement. And yet… none of these clever systems, if the FSB is to be believed, are necessarily clever enough to fend off the forces of consolidation that bring about systemic risks.”

What can I say except to repeat what I as an Executive Director of the World Bank opined when in 2003 I learned that the Basel Committee was going to put so much power in the hands of some few human fallible rating agencies… and now we are to switch into some, or one, hackable AI?

“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg.” 

“A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.”