Risks of AI-based models
Reserve Bank of India (RBI) Governor Shaktikanta Das has warned banks and non-bank financial companies (NBFCs) against relying on algorithms and artificial intelligence (AI) to assess customers for loans. He said that model-based, algorithm lending can “lead to a potential crisis” if the robustness of the models is not appraised properly.
Das was speaking at an annual banking event hosted by Mint newspaper in Mumbai on Thursday. He said that some banks and NBFCs did not have the bandwidth to manage the surge in loans approved by algorithm, and that the RBI had acted preemptively to tighten the restrictions on risky lending in recent months.
How does AI-based lending work?
AI-based lending is a process of using machine learning (ML) and natural language processing (NLP) to analyze various data sources, such as credit history, income level, employment status, social media activity, and behavioral patterns, to determine the creditworthiness of loan applicants. AI-based lending can also automate document processing, fraud detection, and collection management.
AI-based lending can offer several benefits, such as faster loan approval, lower operational costs, higher accuracy, and greater financial inclusion. However, AI-based lending also poses some challenges, such as data quality, bias, transparency, and regulation.
RBI’s measures to improve financial stability
In November, the RBI raised the capital cost of unsecured lending by banks, and followed that up by instructing lenders to offload investments in alternate investment funds (AIFs), or bear hefty provisioning costs against those assets. Das said that these measures were aimed at moderating the growth of consumer credit, which had increased at a faster pace than overall credit in the past few years.
He also said that the RBI had taken steps to improve the governance and supervision of banks and NBFCs, and to enhance the resolution framework for stressed assets. He added that the RBI was closely monitoring the spillover effects of global developments on the domestic financial system, especially in the context of rising inflation and interest rates.
RBI’s stance on exchange rate regime
Das also defended the RBI’s intervention in the foreign exchange market, saying that it was not aimed at influencing the level of the rupee, but at managing volatility and ensuring orderly conditions. He said that the RBI’s exchange rate regime was market-determined, and not a stabilized arrangement as some people had wrongly interpreted.
He said that the RBI’s foreign exchange reserves, which had crossed $700 billion for the first time in December, were adequate to meet any external shocks or contingencies. He also said that the RBI was committed to maintaining price stability and supporting growth, while being mindful of financial stability.