Regulators must not stifle the potential of AI in financial services

Stefani Reynolds/Bloomberg

Despite countless innovations in financial services, the financial wellness of Americans is getting worse. In the past two decades, Black homeownership rates have dropped by 7%, and non-housing-related debt for all families has more than doubled. While Americans' lack of financial literacy certainly plays a role, as a former regulator myself, I'd argue that regulators' fear of the technological unknown is the biggest barrier to progress.

At a December meeting of the Financial Stability Oversight Council, which was formed after the 2008 financial crisis to deal with systemic risks, Treasury Secretary Janet Yellen said, "This year, the council specifically identified the use of artificial intelligence in financial services as a vulnerability in the financial system."

However, I'd argue that AI is also the biggest opportunity in the financial system.

Regulators have historically been wary of technological innovation in financial services. Just last year, the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency issued final guidance on managing risks associated with third-party relationships, demonstrating policymakers' concern around bank and fintech partnerships. This is despite evidence that new financial technologies offer powerful solutions to the very real-world financial problems of real Americans.

For instance, imagine a consumer who has few current assets, but is setting aside $200 per month to invest for their future. After 20 years, assuming an average rate of return, that money would be worth more than $150,000 — enough to pay for a college education, put a down payment on a house or invest in other things that can build generational wealth. But a traditional investment advisor is unlikely to accept that consumer's business because they wouldn't meet the assets under management, or AUM, threshold. However, a fintech using robo-advisors and AI-powered tools would take that customer's business and ultimately provide them a life-changing financial opportunity. 

There's no question that financial illiteracy is a significant contributor to many consumers' financial problems, particularly in underserved communities. The choices consumers make regarding financial products and services can have a profound impact on their financial well-being.

Consider a scenario where a consumer's car breaks down and they lack the funds for repairs. They could either approach their local credit union or their local payday lender. The former might charge them a 15% interest rate, while the latter could impose a staggering 450% interest rate. The first option could help the consumer recover, while the latter could send them spiraling into a prolonged crisis. Being educated enough to understand how to make the right choice matters.

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But literacy only helps if credit unions, community banks and other mainstream financial institutions have the tools and technologies to serve consumers of every socioeconomic level — and in today's world, that means AI. 

This is when the role of regulators and their tolerance of risk becomes paramount. To be fair, tools and technologies come with risks — but, particularly in the case of new AI-based tools, I'd argue strongly, those risks must be weighed against the risks of the status quo, which are significant — particularly for women and people of color. Robo-advisors could be wrong, but so can human advisors with unconscious bias. AI credit-scoring systems might not be perfect, but legacy credit-scoring systems are barely better than a coin toss when it comes to predicting credit risk for middle-tier applicants. 

Regulators can and must create regulations to mitigate the downsides for consumers; otherwise, irresponsible actors will displace responsible ones, with disastrous long-term consequences. At the same time, regulations must be intentionally designed so they don't stifle innovation.

Innovation-positive regulation, responsible financial innovation and thoughtful AI adoption by financial institutions can ensure that the next 20 years don't look like the last 20. Today, financial literacy is less effective than it should be because traditional financial institutions lack the tools and technologies they need to serve new customers that knock on their doors. Many have been slow to adopt these tools because they know regulators are skeptical of them.

Technology is part of the answer and will help legacy financial institutions make a real difference in real American lives, as long as regulators do their part and embrace the opportunities with as much fervor as they shun the risks. I'm confident that my former colleagues at the National Credit Union Administration as well as the other financial regulators are more than up to the task.