OCC Flags AI As 'Emerging' Risk In Banking System

Law360 (December 7, 2023, 9:36 PM EST) -- The Office of the Comptroller of the Currency said Thursday that it's keeping an eye on banks' use of artificial intelligence, warning that widespread adoption of the technology could "present significant challenges" across multiple risk categories.

The OCC said in a report that recent AI advances, including a flurry of generative AI platforms that have come to market, are creating new opportunities for banks to deploy the technology for uses like fraud detection, customer services and credit scoring.

The agency said it also sees "significant" potential for banks to realize more benefits from AI technology as it matures, like new cost savings, improved product and service offerings, expanded underwriting and enhanced internal controls. But the OCC cautioned that use of AI is not without peril, citing concerns about AI model explainability and accuracy, built-in bias, privacy, cybersecurity and consumer protection.

Widespread AI adoption "may also present significant challenges relating to compliance risk, credit risk, reputation risk and operational risk," the OCC said.

"While AI has the potential to provide many benefits, the OCC is also mindful of the associated challenges and risks," the agency said in the report. "The OCC will continue to monitor this rapidly evolving area, including generative AI use."

Thursday's report — the latest in a semiannual series on risks facing the federal banking system — highlighted AI as an "emerging" area of risk and comes amid a broader push by the Biden administration to get a regulatory handle on the technology's manifold potential applications.

Forecasters have said that banks in particular could reap hundreds of billions of dollars in value from generative AI, whose human-like creative capabilities could aid in everything from fielding customer queries to rewriting clunky back-office software and whipping up bespoke client pitches on the fly.

Earlier this week, acting OCC Deputy Comptroller Donna Murphy noted in congressional testimony that the agency has indeed seen banks beginning to experiment with generative AI, though she said that they are doing so "with caution" and that its usage "is not widespread" at this time.

Thursday's report called for other banks interested in AI to take a similarly cautious approach toward the technology, saying the OCC is supportive of banks' efforts to explore new tools like AI so long as they are clear-eyed about the risks involved.

To that end, the agency said that while its existing supervisory guidance doesn't directly address AI, banks should apply the same basic risk management principles to its use.

The newness of a technology doesn't "render existing safety and soundness standards and compliance requirements inapplicable," the agency said.

"It is important that banks manage AI use in a safe, sound, and fair manner, commensurate with the materiality and complexity of the particular risk of the activity or business process(es) supported by AI usage," the OCC said in the report. "It is important for banks to identify, measure, monitor, and control risks arising from AI use as they would for the use of any other technology."

Thursday's report also offered updates on trends for other, more traditional risks facing OCC-regulated institutions, which include national banks and federal thrifts. Collectively, these banks hold about two-thirds of total U.S. commercial banking system assets.

Among those trends, the report said, higher interest rates, elevated inflation and other factors are driving increases in credit risk, which reflects the possibility of losses from debt defaults. Commercial real estate, which has been under particular post-pandemic pressure, is seeing signs of deteriorating credit quality in some markets, the report said.

The report additionally flagged "elevated" levels of operational and compliance risk, in part due to banking's long-term shifts toward increased digitalization and reliance on third-party providers.

Cyberattacks also continue to threaten banks' technology operations — the OCC said the financial sector has seen an increase in distributed denial of service attacks over the past year — and the growth of instant payment services is bringing with it greater risks of fraud and errors, according to the report.

"Banks can aid customers by strengthening controls, educating customers on potential scams, and enhancing internal fraud monitoring capabilities," the OCC said in the report. "Examiners will continue to assess how banks are managing these and other risks related to changes in operating environments driven by these innovations."

The report further noted that banks are facing "heightened" consumer compliance scrutiny. Regulators are putting an emphasis on "ensuring equal access to credit, and fair and consistent treatment of consumers as they adapt to changing customer needs and preferences," the report said, adding that rising interest rates could lead to an increase in relief requests under military borrower protection laws.

The report said banks' deposit management has also been complicated by rising interest rates and should be given special attention, advice that regulators have repeatedly stressed in the wake of this spring's bank failures.

"Stress testing and sensitivity analyses of deposit assumptions remain critical given recent trends in deposit movement and rates as well as uncertainty regarding depositor behavior moving forward," the OCC said in the report.

"Sound liquidity risk management, including processes that ensure sufficient committed capacity to meet contingent liquidity needs" also remains key, the agency added.  

--Editing by Alanna Weissman.

For a reprint of this article, please contact reprints@law360.com.

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