Reserve Bank of India (RBI) Governor Shaktikanta Das issued a cautionary statement on the potential risks associated with the growing reliance on artificial intelligence (AI) and machine learning (ML) in the financial sector.
Speaking at an event in New Delhi, Das underscored that while these technologies offer significant opportunities for businesses to expand and innovate, they also present challenges that could threaten financial stability.
Das expressed concerns that the heavy dependence on AI systems, particularly within the banking and financial industries, could lead to concentration risks. “The heavy reliance on AI can lead to concentration risks, especially when a small number of tech players dominate the market. This could amplify systemic risks, as failures or disruptions in these systems may cascade across the entire sector,” he stated.
The governor further elaborated on the vulnerabilities that AI could introduce, noting that AI systems could be susceptible to cyberattacks and data breaches. One of the inherent challenges of AI, according to Das, is its opacity. This makes it difficult for auditors to assess or interpret the decision-making processes behind AI-driven algorithms, which can result in unintended and potentially harmful market outcomes.
The increasing integration of AI in financial systems, while advantageous in many ways, requires banks and financial institutions to maintain control over their processes. “In the ultimate analysis, banks have to ride on the advantages of AI and BigTech, and not allow the latter to ride on them,” Das emphasised.
Exploring Real-Time Gross Settlement for Global Currencies
Beyond AI and ML, Das touched upon other critical issues concerning India’s financial infrastructure, specifically mentioning the country’s real-time gross settlement system (RTGS). The system, which facilitates immediate and irrevocable transactions between banks, has the potential for further expansion. Das suggested that India’s RTGS could be extended to settle transactions in major trade currencies like the US dollar, euro, and British pound, potentially through bilateral or multilateral agreements.
RTGS, introduced by the RBI, is integral to India’s financial infrastructure, ensuring real-time settlements for both customer and interbank transactions. Das highlighted the possibility of leveraging this system to streamline international trade, potentially reducing time lags and inefficiencies in cross-border payments.
Efforts to Link Cross-Border Payment Systems
Addressing the broader context of cross-border transactions, Das noted efforts by India and other economies to establish connections between fast payment systems. These initiatives aim to reduce the costs and time required for international remittances, which are critical for emerging and developing economies, including India.
He also pointed out the potential for central bank digital currencies (CBDCs) to facilitate efficient cross-border payments. India is currently among a handful of countries experimenting with both wholesale and retail CBDCs, positioning itself at the forefront of digital currency innovation. Das emphasised the importance of such developments in enhancing the speed and security of international transactions.
Financial Stability in a Global Context
Turning to global financial stability risks, Das addressed the divergence in monetary policies across the world, which he believes could result in volatility in capital flows and exchange rates. He referenced the sharp appreciation of the Japanese yen in August, which disrupted global financial markets and triggered reversals in yen-based trading strategies.
Another area of concern highlighted by Das was the rapid expansion of private credit markets, which have grown with minimal regulation and have not been tested during periods of economic stress. He warned that such markets, if left unchecked, could pose risks to overall financial stability, particularly if asset valuations become overextended.
The governor also discussed the risks associated with rising interest rates, noting that higher borrowing costs could increase financial market volatility and put pressure on asset quality. He specifically mentioned commercial real estate (CRE) prices in some regions, warning that price corrections in this sector could put significant strain on smaller banks, which often have substantial exposure to this market.
“The interconnectedness between CRE, non-bank financial institutions, and the broader banking system amplifies these risks,” Das warned. As financial systems become more intertwined, problems in one sector could quickly spread to others, potentially triggering broader financial instability.
Das urged banks to strengthen their liquidity buffers and to stay alert in an environment where social media and online banking have made financial systems more prone to rapid changes.
