RBI Deputy Governor Urges Stronger AI Governance and Customer Education in Financial Sector

Financial firms must flag risks in leveraged products: RBI deputy governor Rajeshwar Rao

MUMBAI: Financial entities have a duty to ensure that customers fully understand the risks associated with leveraged products and speculative investing. Entities also need to shoulder part of the responsibility to educate consumers as it is not only the responsibility of regulators, Reserve Bank of India (RBl) deputy governor Rajeshwar Rao said at a conference by the Indian Institute of Management Kozhikode (IIMK) and the National Stock Exchange (NSE). Rao, who oversees crucial departments of regulation, risk monitoring and enforcement since 2020, said though technology and digital innovations drive financial inclusion, they also bring with them the risk of excessive exposure and over-leveraging. "It is said that the presence of too much light can also lead to blindness, we must be aware of the risk of reckless financialisation. Of late we have seen some concerns of excessive borrowing in the unsecured segment and from derivative euphoria in the capital markets. The temptation of short-term gains can easily overshadow the long-term financial security of individuals," Rao said. He also pointed out the challenges of using artificial intelligence (AI) and machine learning (ML) models like algorithmic bias, fairness, data privacy, and security, which are based on their lack of explainability. "In the absence of explainability, human intervention can end up becoming mere rubber-stamping, rather than responsible oversight, increasing the likelihood of systemic errors," he said. Rao said the continuous learning and evolution of AI models could make them susceptible to data drift and concept drift causing them to misalign with real-world trends, risking incorrect financial decisions and instability. "Regular human oversight and explainability are critical to prevent such risks. While algorithms can provide valuable insights and efficiency, they should be viewed as tools to support, not replace, human judgment," Rao said. Regulated entities must develop the necessary capabilities to implement and comply with evolving regulations. As financial institutions integrate AI, cloud computing, and API-driven finance into their operations, they must also invest in robust governance frameworks and risk management protocols to ensure compliance. "Financial firms can't afford to view regulation as a barrier to innovation - rather, compliance itself must become a core component of their digital strategy. A strong internal culture of risk awareness, ethical AI usage, and customer-centric innovation will be critical in navigating the evolving financial landscape effectively," Rao said. Financial institutions must also navigate the risks of excessive reliance on third-party technology providers, ensuring that regulatory compliance and cybersecurity while ensuring customer protection remain their top priorities, he said. Rao said the banking sector has always emerged stronger from previous disruptions. Banks and NBFCs will have to adapt to the technological changes or risk being made obsolete. "To remain competitive, financial institutions must invest in digital infrastructure, and pivot to a customer-centric, data-driven approach in this new landscape," he said.

Financial entities have to educate customers about risks; tech only a tool: RBI DG Rajeshwar Rao

RBI Deputy Governor Rajeshwar Rao emphasized the need for financial entities to educate customers on the risks of leveraged products and speculative investing. He highlighted challenges posed by technology advancements, such as AI and ML, and stressed the importance of human oversight and robust governance frameworks to ensure compliance and mitigate systemic risks in the evolving financial landscape.Financial entities have a duty to ensure that customers fully understand the risks associated with leveraged products and speculative investing. Entities also need to shoulder part of the responsibility to educate consumers as it is not only the responsibility of the regulator, Reserve Bank of India (RBl) deputy governor Rajeshwar Rao said in speech at a conference organised by the Indian Institute of Management Kozhikode (IIMK) and the National Stock Exchange (NSE). Rao who is incharge of crucial departments of regulation, risk monitoring and enforcement since 2020, said though technology and digital innovations drive financial inclusion, they also bring with them the risk of excessive exposure and over-leveraging. "It is said that presence of too much light can also lead to blindness, we must be aware of the risk of reckless financialization. Of late we have seen some concerns of excessive borrowing in unsecured segment and from derivative euphoria in the capital markets. The temptation of short-term gains can easily overshadow the long-term financial security of individuals," Rao said. He also pointed out challenges of using artificial intelligence (AI) and machine learning (ML) models like algorithmic bias, fairness, data privacy, and security which are based on their lack of explainability. "In the absence of explainability, human intervention can end up becoming mere rubber-stamping, rather than responsible oversight, increasing the likelihood of systemic errors," he said. Rao said the continuos learning and evolution of AI models could make them susceptible to data drift and concept drift causing them to misalign with real-world trends, risking incorrect financial decisions and instability. "Regular human oversight and explainability are critical to prevent such risks....While algorithms can provide valuable insights and efficiency, they should be viewed as tools to support, not replace, human judgment," Rao said. Regulated entities must develop the necessary capabilities to implement and comply with evolving regulations. As financial institutions integrate AI, cloud computing, and API-driven finance into their operations, they must also invest in robust governance frameworks and risk management protocols to ensure compliance. "Financial firms cannot afford to view regulation as a barrier to innovation -- rather, compliance itself must become a core component of their digital strategy. A strong internal culture of risk awareness, ethical AI usage, and customer-centric innovation will be critical in navigating the evolving financial landscape effectively," Rao said. Financial institutions must also navigate the risks of excessive reliance on third-party technology providers, ensuring that regulatory compliance and cybersecurity while ensuring customer protection remain their top priorities, he said. Rao said the banking sector has always emerged stronger from previous disruptions. Banks and NBFCs will have to adapt to the technological changes or risk being made obsolete. "To remain competitive, financial institutions must invest in digital infrastructure, and pivot to a customer-centric, data-driven approach in this new landscape," he said.

RBI Pushes for Stronger AI Governance in Financial Institutions

Disclaimer: This content generated by AI & may have errors or hallucinations. Edit before use. Read our Terms of use "Investment in digital infrastructure and a data-driven approach while subverting risks of heavy dependence on third-party technology providers allows financial institutions to remain competitive'" Reserve Bank of India (RBI) Deputy Governor, M Rajeshwar Rao remarked recently. Rao was giving the inaugural address at the IIM Kozhikode and National Stock Exchange joint Second Annual Conference on Macroeconomics, Banking, and Finance and spoke about the role of digital transformation in finance and the use of artificial intelligence (AI) and machine learning (ML), among other topics. Here are some interesting points Rao discussed: Rao centred his speech around "creative disruptions" or the dismantling of old systems and their replacement by new ones, specifically in the financial sector. The 'India Stack' program comprising innovations like the Unified Payment Interface (UPI), the Account Aggregator (AA) framework, and the Unified Lending Interface (ULI), supplementing the traditional banking system and expanding financial reach, promoted such disruption, he claimed. Rao also noted that digital lending has helped integrate underserved segments into the formal financial system. His comments echo RBI's broader ULI push, as evident in the recent meeting between the RBI Governor and MDs and CEOs of select non-banking financial institutions (NBFCs), wherein the latter were urged to adopt the ULI framework. Previously, RBI had explained that ULI would reduce credit appraisal time for smaller and rural borrowers alongside digitising access to the customers' financial and non-financial data. Besides ULI, UPI also enables greater financial inclusion, especially for the informal sector, initially dealing in cash, Rao explained. UPI's ubiquity creates financial footprints for members of the informal sector, which can be used by financial service providers (FSPs) in the account aggregator framework. These financial footprints also help extend credit to new-to-credit individuals, gig workers, and small businesses without formal credit histories. Recently, the central bank extended credit line facilities (pre-approved borrowing limits) via UPI for small finance banks, aiming to improve access to short-term credit for small businesses. This adds to RBI's provision of constant support to the UPI framework through acts like levying zero merchant discount rates (MDR) and even having spent Rs 3,600 crore on its promotion (and that of RuPay) between 2021-24. Rao highlighted the growing discussions on AI adoption among financial institutions, including commercial banks and regulators. Further, he outlined three key areas where AI adoption could aid financial services- risk assessment & credit scoring, enhancing customer experience, and fraud detection. AI-driven models can analyse copious amounts of data like transaction patterns, utility bill payments, and e-commerce behaviour to establish a borrower's creditworthiness and also predict stress among existing borrowers, thereby formulating remedial measures. Additionally, financial institutions can leverage AI to offer customers hyper-personalised financial products, bettering their experience. Finally, AI-based techniques enabling fraud detection are critical for real-time payments and digital transactions, where cyber threats and frauds loom, Rao opined. Previously, RBI's subsidiary unit Reserve Bank Innovation Hub (RBIH) launched MuleHunterAI, a tool to detect and flag mule accounts enabling financial fraud. The move came after RBI noted discrepancies like high false positives and longer turnaround times in the older static-rule-based system. Rao stated that the challenges posed by AI like algorithmic bias, data privacy, and security stem from a "lack of explainability". Elaborating on this, he noted that since AI systems function like black boxes, producing outputs that are difficult to interpret for their developers, this system falls short in the financial sector, driven by trust, accountability, and regulatory compliance. Barring this explainability, human intervention acts as "rubber stamping" instead of responsible oversight, he concluded. Moving forward, while AI systems undergoing 'dynamic adaption' are beneficial, they can increase occurrences of data drifts (a situation where the data inputs a system is trained on differs from the data inputs it is applied to) and concept drifts (a situation where data evolution invalidates the model). Rao claimed that such models risk providing incorrect financial decisions and instability and must be countered with regular human oversight and explainability. Further, he noted that the shortage of professionals to oversee AI models exacerbates the challenges associated with the lack of explainability. Moreover, "automation complacency" or excessive reliance on technology despite certain situations requiring careful judgement is another risk of AI-based decision models, Rao added. While acknowledging the benefits of digital transformation in the financial sector, Rao explained that concerns around excessive borrowing have been on the rise. To counter this, he called upon financial entities to ensure increased financial literacy and consumer awareness concerning the risks of leveraged products and "speculative investing". Concerning the integration of AI, cloud computing, and API-driven finance, Rao explained that financial institutions must install robust governance and risk management frameworks. Going forward, Rao remarked that entities must prioritise central risk awareness, ethical AI usage, and customer-centric innovation, while "navigating the evolving financial landscape.