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Financial Services Law Insights and Observations

Federal Reserve Governor, FDIC Chairman discuss fintech

Fintech Federal Reserve Artificial Intelligence

Fintech

On November 13, Federal Reserve Governor Lael Brainard spoke at the “Fintech and New Financial Landscape” conference hosted by the Federal Reserve Bank of Philadelphia to discuss the potential implications associated with artificial intelligence (AI) innovation and advise regulators to remain diligent in their approach to understand and regulate the use of AI by financial institutions when augmenting or replacing traditional financial processes. Brainard’s prepared remarks emphasize the benefits and potential risks to bank safety and consumer protection that new AI applications pose. Noting, however, that many AI tools are proprietary and may be shielded from close scrutiny, Brainard suggested that existing regulations and supervisory guidance such as the Federal Reserve Board’s guidance on model risk management and vendor risk management could prove helpful in this space, which requires strong controls. Among other things, Brainard discussed the use of AI models to make credit decisions, and noted the risk of “opacity and explainability” challenges, which would make it difficult to explain how consumer credit decisions were determined and could “make it harder for consumers to improve their credit score by changing their behavior.” However, Brainard noted that the “AI community is responding with important advances in developing ‘explainable’ AI tools with a focus on expanding consumer access to credit.”

Brainard also commented that “[r]egulation and supervision need to be thoughtfully designed so that they ensure risks are appropriately mitigated but do not stand in the way of responsible innovations that might expand access and convenience for consumers and small businesses or bring greater efficiency, risk detection, and accuracy.” Moreover, supervisory guidance to firms must be read in the context of the “relative risk,” and the “level of scrutiny should be commensurate with the potential risk posed by the approach, tool, model, or process used.”

At the same conference, FDIC Chairman Jelena McWilliams also discussed the use of innovation to expand banking access to more consumers, including lower transaction costs and increases in credit availability, but emphasized that millions of “unbanked or underbanked” U.S. households do not experience these technological benefits. McWilliams stated that “[i]t will be up to institutions to leverage technology and develop products to reach these consumers.” McWilliams also discussed the FDIC’s planned Office of Innovation, which will, among other things, evaluate ways to support community banks with limited resources for fintech research and development and explore policy changes to encourage more innovation, particularly “in the areas of identity management, data quality and integrity, and data usage or analysis.” Additionally, McWilliams stated that advances in technology and data analytics will present opportunities for managing risk and change the process in which regulators handle oversight in areas such as Bank Secrecy Act/anti-money laundering compliance and consumer privacy.

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