Bank of England Warns of AI-Driven Market Volatility and Manipulation Risks

UK Regulators Eye Wall Street's Use of AI on Trading Floors

The Bank of England plans to closely monitor the use of artificial intelligence by banks and hedge funds over concerns that the technology could trigger a market crash or manipulation without humans even knowing about it. The central bank's Financial Policy Committee warned that the technology could destabilize markets or act in other adverse ways in a new report on AI published Wednesday. It added that AI was making such rapid headway among hedge funds and other trading firms that humans may soon not understand what the models are doing.

Autonomous AI Could Wreak Havoc on Stock Market, Bank of England Warns

The Bank of England warned that AI bots could converge on similar trading strategies, exacerbating downturns or bubbles. The stock market is already an unpredictable place, and now the Bank of England has warned that the adoption of generative AI in financial markets could produce a monoculture and amplify stock movements even more. It cited a report by the bank's financial policy committee that argued autonomous bots might learn volatility can be profitable for firms and intentionally take actions to swing the market. Essentially, the bank is concerned that the phrase "buy the dip" might be adopted by models in nefarious ways and that events like 2010's infamous "flash crash" could become more common. With a small number of foundational models dominating the AI space, particularly those from OpenAI and Anthropic, firms could converge on similar investment strategies and create herd behavior. But more than just following similar strategies, models function on a reward systemâ€"when they are trained using a technique called reinforcement learning with human feedback, models learn how to produce answers that will receive positive feedback. That has led to odd behavior, including models producing fake information they know will pass review. When the models are instructed to not make up information, it has been shown they will take steps to hide their behavior. The fear is that models could understand that their goal is to make a profit for investors and do so through unethical means. AI models, after all, are not human and do not intrinsically understand right versus wrong. “For example, models might learn that stress events increase their opportunity to make profit and so take actions actively to increase the likelihood of such events,†reads the report by the financial policy committee. High-frequency algorithmic trading is already common on Wall Street, which has led to sudden, unpredictable stock movements. In recent days, the S&P 500 rose over 7% before crashing back down after a social media post misinterpreted comments by the Trump administration to suggest that it would pause tariffs (which appears to be actually happening now, after an earlier denial). It is not hard to imagine a chatbot like X's Grok ingesting this information and making trades based on it, causing big losses for some. In general, AI models could introduce a lot of unpredictable behavior before human managers have time to take control. Models are essentially black boxes, and it can be hard to understand their choices and behavior. Many have noted that Apple's introduction of generative AI into its products is uncharacteristic, as the company has been unable to control the outputs of the technology, leading to unsatisfactory experiences. It is also why there is concern about AI being used in other fields like healthcare where the cost of mistakes is high. At least when a human is in control there is someone to be held accountable. If an AI model is manipulating the stock market and the managers of a trading firm do not understand how the model works, can they be held accountable for regulatory violations like stock manipulation? To be sure, there is a diversity of AI models that behave differently, so it is not a guarantee that there will be sudden stock collapses due to one model's suggestions. And AI could be used for streamlining administrative work, like writing emails. But in fields with a low tolerance for error, widespread AI use could lead to some nasty problems.

Bank of England says AI software could create market crisis for profit

Concern grows over programs deployed to act with autonomy that might 'exploit weaknesses' Increasingly autonomous AI programs could end up manipulating markets and intentionally creating crises in order to boost profits for banks and traders they work for, the Bank of England has warned. Artificial intelligence's ability to "exploit profit-making opportunities" was among a wide range of risks cited in a report by the Bank of England's financial policy committee (FPC), which has been monitoring the City's growing use of the technology. The FPC said it was concerned about the potential for advanced AI models - which are deployed to act with more autonomy - to learn that periods of extreme volatility were beneficial for the firms they were trained to serve. Those AI programs might "identify and exploit weaknesses" of other trading firms in a way that triggers or amplifies big moves in bond prices or stock markets. "For example, models might learn that stress events increase their opportunity to make profit and so take actions actively to increase the likelihood of such events," the FPC report said. Those same models could "facilitate collusion or other forms of market manipulation ... without the human manger's intention or awareness", the committee warned. AI is increasingly being used by a range of financial companies looking to develop new investment strategies, cut down on run-of-the mill administrative tasks, or even automate decision making around loans. A recent report by the International Monetary Fund showed that more than half of all patents by high-frequency or algorithmic trading firms are now related to AI. But its use stands to create new vulnerabilities, including "data poisoning", where bad actors manipulate AI training models. Criminals could also use AI to fool banks, circumvent their controls, and get away with money laundering and terrorism funding. And the risk that a large number of companies rely on the same AI providers could mean that a single error in their models could leave financial firms taking much larger risks than they realise and create widespread losses across the sector. "This type of scenario was seen in the 2008 global financial crisis, where a debt bubble was fuelled by the collective mispricing of risk," the FPC warned.

BofE eyes AI's risk to financial stability

This content has been selected, created and edited by the Finextra editorial team based upon its relevance and interest to our community. With market participants around the world investing billions of dollars into AI efforts, regulators are working to balance support for innovation and managing potential risks. The Financial Policy Committee has highlighted several such risks. Among them is that unknown data or model flaws might mean that a company's exposures turn out to have been incorrectly measured or interpreted. Equally, the widespread use of a small number of open-source or vendor-provided models or underlying data sets risks seeing firms take correlated positions and acting in a similar way during a stress, thereby amplifying shocks. The reliance on a small number of venders or a given service could also generate systemic risks in the event of disruptions to them, especially if is not feasible to migrate rapidly to alternative providers. Writes the committee: "For example, under a scenario in which customer-facing functions have become heavily reliant on vendor-provided AI models, a widespread outage of one or several key models could leave many firms unable to deliver vital services such as time-critical payments." AI could also impact the cyber threat environment. While the technology can help banks tackle this threat, it could also be used by malicious actors to carry out attacks against the financial system. "The effective monitoring of AI-related risks is essential to understand whether additional risk mitigations might be warranted in support of safe innovation, what they might be, and at what point they may become appropriate," says the committee.

Bank of England Warns of Higher Market Volatility From AI-Driven Trading | PYMNTS.com

With better risk management and more personalized investment strategies, AI could help firms reduce herd-like behavior. The use of artificial intelligence in algorithmic trading could exacerbate market volatility and amplify financial instability, according to a policy paper by the Bank of England released this week. As global markets reel from President Donald Trump's tariff policy changes, the United Kingdom's central bank warned that the widespread use of AI for trading and investing could lead to a "herding" behavior that could raise the chance of sudden market drops, especially during times of stress because firms might sell off assets at once. As more firms use AI for investing and trading, there's a risk that many will end up making the same decisions at the same time, the paper said. "Greater use of AI to inform trading and investment decisions could help increase market efficiency," per the paper. "But it could also lead market participants inadvertently to take actions collectively in such a way that reduces stability." For example, the use of more advanced AI-based trading strategies could lead firms to "taking increasingly correlated positions and acting in a similar way during a stress, thereby amplifying shocks," according to the paper. Such market instability can affect the amount of capital available to businesses since they can't raise as much when markets are down. The report comes as global equity and bond markets have been on a roller coaster since the Trump administration announced a minimum of 10% tariffs on imports from all countries, with China, the European Union and a few other countries getting hit with higher rates. The Dow Jones Industrial Average has fallen by 6.2% since Trump's April 2 announcement, while the S&P 500 gave up 7.1% and the Nasdaq Composite fell by 6.9%. The benchmark 10-year Treasury yields rose from 4.053% to 4.509% over the same time frame as investors flocked to safety. Federal Reserve Chair Jerome Powell said tariffs are "likely to raise inflation in coming quarters" and "it is also possible that the effects could be more persistent," according to a transcript of his April 4 speech before the Society for Advancing Business Editing and Writing. Inflation is a key statistic influencing monetary policy such as the direction of the Fed funds rate. Powell's comments came five days before Trump decided to pause tariffs for 90 days for nearly 60 countries, except China. Read also: Trump Boosts Tariffs on Low-Value Packages Again After China Retaliates The use of AI in algorithmic trading could exacerbate these extremes because many companies rely on the same AI models or data, leading them to act similarly, according to the BoE paper. Although AI might make markets more efficient by processing information faster than humans, it could also make them more fragile and less able to handle shocks, the paper said. The central banker said the International Monetary Fund (IMF) identified herding and market concentration as the top risks that could come from wider adoption of generative AI in the capital markets. The IMF's 2024 report said the adoption of AI in trading and investing is "likely to increase significantly in the near future." While AI may reduce some financial stability risks through improved risk management and market monitoring, at the same time "new risks may arise, including increased market speed and volatility under stress" and others. On the positive side, AI could help financial services firms manage risk more effectively by making better use of the data they already have, the BoE paper said. With stronger risk management, firms are less likely to be caught off guard when prices suddenly drop. That means they might not need to rush into selling off assets all at once, which is what happens during a fire sale. The resulting damage caused by market selloffs could be mitigated or even avoided. The central banker also pointed to another potential mitigating factor. If investment managers use AI to tailor strategies specifically for each client, it could lead to more market stability since people won't hold the same assets.

Bank of England to monitor AI use in finance over potential market risks By Investing.com

Investing.com -- The Bank of England has announced plans to closely monitor the use of artificial intelligence (AI) in the finance sector, including banks and hedge funds. The move comes amid concerns that the technology could lead to market crashes or manipulation without human awareness. The central bank's Financial Policy Committee (FPC) highlighted these potential risks in a new report on AI, published on Wednesday. The report suggests that AI could have a transformative impact on many sectors of the UK economy, including finance. The technology has the potential to save workers' time on a wide range of tasks, thereby possibly boosting productivity. It could enhance firms' decision-making processes and help make products and services better and more tailored to customers' needs. In the financial sector, AI is already helping many institutions to automate and optimize their existing internal processes, such as code generation, as well as their interactions with customers. Advanced forms of AI are expected to increasingly inform firms' core financial decisions, such as credit and insurance underwriting, potentially shifting the allocation of capital. However, the FPC also warns of the uncertainties surrounding the rapid development and deployment of advanced AI. These uncertainties could result in financial stability risks, which can impact households and businesses. The FPC is particularly concerned about the following areas: 1. Greater use of AI in banks' and insurers' core financial decision-making could introduce risks, especially in relation to models and data. These risks could have systemic consequences if common weaknesses in widely used models cause many firms to misestimate certain risks, leading to mispricing and misallocation of credit. 2. Greater use of AI in financial markets could reduce stability. For instance, the potential future use of more advanced AI-based trading strategies could lead to firms taking increasingly correlated positions and acting in a similar way during a stress, thereby amplifying shocks. 3. Operational risks related to AI service providers could impact the operational delivery of vital services. Financial institutions generally rely on providers outside the financial sector for AI-related services. Reliance on a small number of providers could lead to systemic risks in the event of disruptions to them. 4. Changing external cyber threat environment. While AI might increase financial institutions' cyber defensive capabilities, it could also increase malicious actors' capabilities to carry out successful cyberattacks against the financial system. The FPC plans to build out its monitoring approach to track the development of AI-related risks to financial stability. This approach will need to be flexible and forward-looking given the uncertainties and potential pace of change in AI. The FPC will make use of a blend of quantitative and qualitative information sources, including the regular Bank and FCA Survey on AI in UK financial services, the AI Consortium, and targeted market and supervisory intelligence gathering. The FPC will continue to adapt and add to these tools as the risk environment evolves.