Artificial intelligence poses both emerging opportunities and risks to banking, according to a recent report from the Office of the Comptroller of the Currency.
“It is important that banks manage AI use in a safe, sound and fair manner, commensurate with the mentality and complexity of the particular risk of the activity or business processes supported by AI usage,” according to the Dec. 7 semiannual risk report.
AI reportedly poses risks both through third-parties and to cybersecurity and consumer protection. The technology can also pose bias and discrimination-related challenges if improperly trained or used with data sets that use data that perpetuates past bias.
“Developments in the technology may reduce costs and increase efficiencies; improve products, services and performance; strengthen risk management and controls; and expand access to credit and other banking services,” according to the OCC. “Widespread adoption of AI, however, may also present significant challenges relating to compliance risk, credit risk, reputation risk and operational risk.”
Banks are using AI for customer chatbots, to detect fraud and for credit scoring. Generative AI — which creates new content much like a human would — has especially drawn regulatory attention as commercially-available large language model tools have made the use of generative AI more accessible.
According to a June 2023 survey from accounting firm KPMG, 66 percent of bank executives said their organization will likely use the technology to enable more advanced visual assistants and chatbots, and 62 percent expected it will be used for customer service and personalization. Executives identified fraud detection and prevention as the No. 1 application for generative AI in financial services.
Banks are also wary of the risks associated with the technology. According to KPMG, 69 percent identified generative AI privacy concerns as a high priority, up from 56 percent earlier in the year.
According to the OCC risk report, the federal banking system remains in strong condition. Defying widespread predictions of a recession, U.S. GDP increased at a 2.1 percent annual rate in the second quarter due to consumer spending remaining strong, near its 2.2 percent pace in the first quarter. “Banks should continue to guard against complacency to ensure they maintain the ability to withstand potential future economic challenges,” according to the OCC.
Return on equity for community banks was mixed even as ROE for the broader banking sector increased to 13.3 percent in June from 11.6 percent from 2022. Overall net income increased 5 percent in June for community banks on an annualized basis, far lower than the 21 percent rise in the broader banking system.
Though higher interest rates continued to lift loan yields and net interest income, funding costs, securities valuations and liquidities continued to face pressure in the higher rate environment. Higher interest rates, rising risks in commercial real estate lending, ongoing inflation, a drop in corporate profits and the potential for slower economic growth have also posed risks in the second half of this year. Key performance indicators are reportedly beginning to show borrower stress across asset classes.
Increased deposit rates, broad market liquidity contraction and growing reliance on wholesale funding began to impact NIMs through the first half of this year. Deposit and liquid asset trends reportedly stabilized in the latter part of 2023, but those levels were supported by a greater reliance on wholesale funding. Interest rate rises were adversely impacting investment portfolio values.
Banks continue to face elevated compliance risks due to a heightened focus on ensuring equal access to credit and fair treatment of consumers; the rising use of new technology to deliver products and services; expanded partnerships with third parties such as fintech firms; and increases in BSA/AML risk.
“Banks continue to leverage new technology to further digitization efforts, offering innovative products and services to meet customer demands,” according to the OCC. “Increasing digitization efforts can also heighten risk of fraud and error, including fraud targeting peer-to-peer and other faster payment platforms.”