Artificial intelligence (AI) is transforming industries across the globe, and central banks are no exception. According to a new report by the Bank for International Settlements (BIS), central banks must embrace AI to harness its full potential and anticipate its far-reaching impacts on the economy and financial systems.
The call to action underscores the urgency for policymakers to leverage AI not only to enhance their own operations but also to maintain financial stability. This directive is detailed in a special chapter of the BIS Annual Economic Report 2024, which lays out the implications of new AI applications for central banks.
Established in 1930, 63 central banks own the BIS, representing countries from around the world that together account for about 95 per cent of world GDP. Its head office is in Basel, Switzerland and it has two representative offices: in Hong Kong SAR and in Mexico City, as well as Innovation Hub Centres around the world.
Its new report suggests that the job of central banks as stewards of the economy will also be directly affected as frontline users of AI tools.
The promise and perils of AI in finance
AI offers significant benefits for the financial sector, enhancing efficiencies in lending, payments, insurance, and asset management. For instance, machine learning models excel in processing vast amounts of data, enabling more accurate credit assessments and risk evaluations. These capabilities can streamline operations, reduce costs, and improve decision-making processes.
However, with these benefits come new risks. AI’s capabilities can be exploited for sophisticated cyber attacks, and its widespread adoption could introduce systemic risks such as herding behaviour in financial markets. The BIS highlights the need for robust cybersecurity measures and vigilant risk management practices to mitigate these threats.
Central banks as AI pioneers
Central banks are uniquely positioned to lead the integration of AI within the financial system. As early adopters of machine learning, they have already laid the groundwork for utilising AI to process unstructured data and detect patterns that traditional methods might miss. The BIS Innovation Hub is at the forefront of this effort, with projects like Aurora, which aims to identify money laundering activities, and Raven, focused on enhancing cyber resilience.
Cecilia Skingsley, head of the BIS Innovation Hub, focuses on this point: “Central banks were early adopters of machine learning and are therefore well positioned to make the most of AI’s ability to impose structure on vast troves of unstructured data.
“For example, Project Aurora explores how to detect money laundering activities from payments data and Project Raven uses AI to enhance cyber resilience, to mention just two from our portfolio.”
The use of AI in central banking extends to real-time economic analysis, or nowcasting. By leveraging AI to analyse real-time data, central banks can make more accurate predictions about inflation and other economic variables. This capability is crucial for maintaining financial and price stability, as it allows for more responsive and informed policy decisions.
Hyun Song Shin, head of research and economic adviser at the BIS, highlights the transformative potential of AI: “New generation AI models have captured our collective imagination through their uncanny abilities, but they also have a direct bearing on how central banks do their jobs.
“Vast amounts of data could provide us with faster and richer information to detect patterns and latent risks in the economy and financial system. All this could help central banks predict and steer the economy better.”
Data: The cornerstone of AI
The rise of AI has elevated the importance of data as a critical resource. Central banks must prioritise data governance and foster cooperation to build a community of practice, says the report. Sharing knowledge, best practices, and AI tools across borders will be essential to fully realising AI’s potential.
Data-driven decision-making will become increasingly central to central banking, suggests the BIS. AI can sift through vast datasets to identify financial system vulnerabilities, enabling authorities to pre-emptively address risks. This proactive approach is vital in an era where financial markets and the broader economy are more interconnected than ever.
AI’s economic implications
AI will reshape labour markets, productivity, and economic growth as it integrates into the economy. AI-driven automation could displace certain jobs, raising concerns about employment and income inequality. However, it also presents opportunities for new job creation in AI-related fields and other sectors benefiting from enhanced productivity.
Central banks will need to monitor these shifts closely. The report suggests that the short-term impact of AI might reduce inflationary pressures as supply outstrips demand. Over time, as AI-driven efficiencies translate into higher incomes and increased demand, inflation dynamics could shift, requiring adaptive monetary policies.
Central banks also face a critical decision between using off-the-shelf AI models and developing custom solutions in-house. While external models may offer cost advantages and quicker implementation, they also pose risks related to transparency and dependency on private sector providers. The BIS cautions that over-reliance on a few external providers could concentrate operational risks and undermine central banks’ independence and effectiveness.
Developing in-house AI capabilities, though potentially more resource-intensive, offers greater control and customisation. This approach allows central banks to tailor AI tools to their specific needs and ensure alignment with their mandates.
The path forward
Central banks are at a pivotal juncture. Embracing AI is not just an option but a necessity to stay ahead of technological advancements and safeguard financial stability. The BIS report underscores the importance of proactive and coordinated efforts to harness AI’s potential while mitigating its risks.
As stewards of monetary and financial stability, central banks must lead by example, integrating AI into their operations and setting the standard for the broader financial sector, says the BIS. By doing so, they can navigate the complexities of the AI revolution and ensure a stable and prosperous economic future.
The BIS will publish the Annual Economic Report 2024 in full on 30 June, providing insights into transformative trends.
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