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A top official at the US Federal Reserve has said that financial institutions (FIs) should look at generative AI (GenAI) as an opportunity to "enhance" their human staff, not "replace" them.

Speaking at the  (CFR) in New York this week, the Fed’s vice chair of supervision, Michael Barr, offered two scenarios for how GenAI may affect the financial sector.

In both scenarios — “transformative change” or “incremental” productivity gains — Barr said that FIs will use GenAI for an increasing number of processes, and that regulators will have a role to play in supervising these changes.

“So long as financial regulators, enterprise risk managers and others charged with managing downside risks prioritise efforts to keep pace with the evolving financial ecosystem, there's nothing to suggest a wholesale transformation of the balance of risks,” he said.

“Of course, keeping pace will pose challenges, and it's important that we all focus on the need to meet these risks.”

Impact of GenAI

Offering some examples of where FIs could see productivity gains through GenAI, Barr said that both compliance and non-compliance functions are likely to be affected.

“Community banks may leverage GenAI-powered chatbots to provide customised financial advice rooted in local knowledge, while institutions of all sizes continue to advance the use of GenAI for compliance monitoring, fraud detection, risk management and document analysis,” he said.

“The impact to society would be incrementally positive in this state of the world. Humans would use GenAI as a tool to deliver goods and services that we currently produce in a more efficient way. Productivity would go up. The economy would grow at a faster pace.”

However, one of the risks inherent in GenAI, Barr noted, is that smaller, less-regulated firms are likely to deploy the technology first, and to reap the benefits earlier.

This could result in certain banking activities being pushed out to the “less transparent corners” of the financial sector, he said.

In such a scenario, larger, more-regulated firms would also look to accelerate their own incorporation of GenAI, to compete with their more “nimble” rivals.

“In the realm of regulation, frameworks for understanding model risk may need to be updated to address the complexity and challenges of explaining AI methods and the difficulty of assessing data quality,” said Barr.

“We also should monitor how the introduction of this technology changes the banking landscape.”

Next steps

Going forward, the Fed vice chair proposed that FIs and regulators, including the Federal Reserve, invest in new resources to understand GenAI technology, incorporate into their workflow and train staff on how to use it responsibly.

“Beyond the financial sector, collaboration between governments, private industry and research institutions will be critical to ensure that GenAI systems are not weaponised in catastrophic ways,” 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.”