MUMBAI: Reserve Bank governor Shaktikanta Das has asked banks to remain alert in the social media space and also strengthen their liquidity buffers given the risks arising from the growing digitization of the financial markets which if not addressed well lead to financial stability risks.
Addressing the RBI-organised function in the Capital as part of the 90th-year celebrations of the Reserve Bank of India on Monday, Das said, it is well-recognised that the growing digitalisation of financial services has enhanced the efficiency of the financial sector across the globe. At the same time, it has also brought in several challenges which central banks have to deal with.
“In the modern world with deep social media presence and vast access to online banking with money transfers happening in seconds, rumours and misinformation can spread very quickly and can cause liquidity stress. Banks have to remain alert in the social media space and also strengthen their liquidity buffers,” the governor cautioned lenders.
Elucidating his apprehensions further, Das said the latest technological advancements such as artificial intelligence (AI) and machine learning (ML) have opened new avenues of business and profit expansion for financial institutions. At the same time, these technologies also pose financial stability risks.
“The heavy reliance on AI can lead to concentration risks, especially when a small number of technology providers dominate the market. This can amplify systemic risks, as failures or disruptions in these systems may cascade across the entire financial sector. Moreover, the growing use of AI spawns new vulnerabilities, such as increased susceptibility to cyberattacks and data breaches.
“Additionally, AI's opacity makes it difficult to audit or interpret the algorithms which drive decisions. This can potentially lead to unpredictable consequences in the markets. Therefore, banks and other financial institutions must put in place adequate risk mitigation measures against all these risks. In the ultimate analysis, banks have to ride on the advantages of AI and Bigtech and not allow the latter to ride on them,” said Das and pointed to last years run on a few American banks after massive cash withdrawals through the online medium.
Noting that central banks are treading in the uncharted terrain of a twilight zone today, especially since the pandemic and the onset of the Russia-Ukraine war in February of 2022, he said “today, like never before in the five centuries of their existence, central banks are confronted with a future where their mandates, their functions and their performances are all up for unforgiving scrutiny leading to a tectonic transformation in the environment they are operating now.”
Structural changes are underway that have the power to fundamentally alter the context of central banking with headwinds from geo-economic fragmentation; muscular industrial, trade and financial policies that are already reshaping supply chains and the availability of critical minerals, intermediates, resources and services; new technologies; and climate change, he said noting in this rapidly evolving environment, central banks are required to navigate not just known unknowns but unknown unknowns too.
Warning of rising public debt, he said another challenge staring at central banks today emanates from soaring public debt caused, in considerable measure, by the pandemic-related fiscal stimuli and the subsequent efforts for fiscal consolidation not gaining adequate traction.
Galloping public debt is becoming a binding constraint on monetary policy in several countries. After the pandemic, global public debt surged to 93.2 per cent of GDP in 2023 and is likely to increase to 100 per cent of GDP by 2029. In major economies, debt-GDP ratios are on an upward trajectory, raising concerns about their sustainability and their negative spillovers for the broader global economy. In several other countries, central banks are willy-nilly expected to facilitate financing of such huge public debts.
The debt overhang is simmering underneath the radar of central banks, threatening to un-anchor inflation expectations and undermine macroeconomic stability, he added.
Das also frowned up on the divergence in global monetary policies – monetary easing in some economies, tightening in a few, and pausing in several other economies can be expected to lead to volatility in capital flows and exchange rates, which may disrupt financial stability. We saw a glimpse of this with the sharp appreciation of the Japanese yen in early August which led to disruptive reversals in the yen carry trade and rattled financial markets across the globe, he said.,
Another concern he raised is about the faster growth of private credit markets which have expanded rapidly with limited regulation. “They pose significant risks to financial stability, particularly since they have not been stress-tested in a downturn.”