FRB Governor Waller Reviews Risks and Benefits of Tokenization and AI

Federal Reserve Board Governor Christopher J. Waller considered the risks and benefits of tokenization and artificial intelligence as they gain prominence within the banking industry.

In a speech, "Innovation and the Future of Finance," at the Global Interdependence Center, Mr. Waller described innovation as a "double-edged sword" that created both new efficiencies and risk mitigants, while also fostering new or worsening existing risks.

Tokenization

Mr. Waller identified several advantages for banks that use blockchain over traditional transactions, including:

• faster or even "near-real time transfers" which can (i) create control for parties to determine settlement times, (ii) enhance efficiencies and (iii) reduce liquidity risks; and
• the use of smart contract functionalities which allows for (i) mitigation of settlement and counterparty credit risks by ensuring that the buyer will not pay until the seller has delivered and (ii) greater flexibility for parties to decide when the transactions will settle.

While acknowledging that real-time transfers bring new risks and that smart contracts have potential cyber vulnerabilities, he underscored the "considerable promise" these new innovations create for improving transactions.

Artificial Intelligence

Mr. Waller identified new use cases for AI in the banking industry, such as:

• generating personalized product suggestions and marketing emails for customers;
• increasing the range of customer service applications, including chatbots that can (i) reset passwords, (ii) locate a bank branch or ATM and (iii) provide account balances;
• monitoring fraud; and
• refining the credit underwriting process and analyses to speed up underwriting decisions and lower loan pricing.

Mr. Waller also identified the "novel" risks associated with AI, including (i) biases in data sets and (ii) the lack of "explainability" on how an AI model provides an output.