The next big financial crisis will emerge from AI says SEC Chairman Gary Gensler.
Concerns are rising about big firms using artificial intelligence which may lead to systemic risk “posed by the technology’s proliferation.”
Data aggregators and AI platforms could be major components of future financial system “fragility,” Chairman Gensler said Tuesday at a conference in Washington hosted by the Financial Industry Regulatory Authority, Wall Street’s self-regulatory body.
Observers years from now might look back and say “the crisis in 2027 was because everything was relying on one base level, what’s called [the] generative AI level, and a bunch of fintech apps are built on top of it,” Mr. Gensler said, per WSJ.
Banks and other financial institutions have employed AI in a variety of functions, including for the normally laborious compliance work involved in sizing up new customers or checking for suspicious transactions.
But despite the possible efficiency gains, the systems should be closely scrutinized, the SEC Chairman continued.
“You don’t have to understand the math, but [you have] to understand, really, how the risk management is managed,” he said, highlighting the potential for biased decisions.
Law enforcement agencies last month said they would tackle AI discrimination and bias in areas such as lending, housing and hiring.
Some smaller jurisdictions have also taken steps to rein in the technology, per WSJ.
Sam Altman, the chief executive of ChatGPT creator OpenAI, on Tuesday called on Congress to create licensing and safety standards for advanced AI as lawmakers begin a bipartisan regulatory push.
Will AI Create Systemic Risk in the Financial Markets?
The retail investor community argues that big hedge funds and market makers have already created massive systemic risk in the financial markets, without the need for artificial intelligence (AI).
Algorithmic high frequency trading (HFT), is already a prime example of how the markets don’t need AI to create systemic risk in the financial markets.
“The increased intensity of order flow co-movement is a potential mechanism of the price change co-movement.
These increasing co-movements signify the heightened systemic risk posed by high-speed trading,” says SSRN, a research network.
One of the biggest risks of algorithmic HFT is the one it poses to the financial system.
A July 2011 report by the International Organization of Securities Commissions (IOSCO) Technical Committee noted that because of the strong inter-linkages between financial markets, such as those in the U.S., algorithms operating across markets can transmit shocks rapidly from one market to the next, thus amplifying systemic risk.
The report pointed to the Flash Crash of May 2010 as a prime example of this risk.
The speed at which most algorithmic high-frequency trading takes place means one errant or faulty algorithm can rack up millions in losses in a short period.Investopedia
“Algorithmic HFT has a number of risks, the biggest of which is its potential to amplify systemic risk.
Its propensity to intensify market volatility can ripple across to other markets and stoke investor uncertainty.
Repeated bouts of unusual market volatility could wind up eroding many investors’ confidence in market integrity”, per Investopedia.
Retail investors argue that Chairman Gary Gensler should focus on the issues that are currently increasing the probability of systemic risk today rather than focusing on AI.
Recent SEC News
JPMorgan (NYSE:JPM) CEO Jamie Dimon is urging the SEC to ban shorting bank stocks.
Days after White House press secretary Karine Jean-Pierre said President Biden’s administration was looking into short seller activity around bank shares in the United States, triggering predictions of a possible ban, JPMorgan CEO has expressed his view that short-selling of bank stocks should, indeed, be prohibited.
Specifically, Jamie Dimon believes that regulators “vigorously” go after unscrupulous short-sellers, or anyone doing anything wrong in terms of stock options, derivatives, and short-sales, as he told Bloomberg TV anchor Francine Lacqua in an interview published on May 11.
An SEC official who spoke on condition of anonymity told FOX Business a short sale ban is “not something the commission is currently contemplating.”
However, bankers continue to push for a short sale ban on banking stocks despite the claims.
In September 2008, big banks were on the verge of collapse.
The SEC enacted a 21-day ban on shorting the shares of the remaining big banks.
People close to the SEC say Gensler will have to propose the ban himself and push it through the full five-member commission on a party-line vote.
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