States Move to Regulate AI in Financial Services

The financial services industry increasingly uses AI in its operations, including utilizing AI to assist in core decision-making and essential functions. This has raised concern among lawmakers who are seeking to regulate the sector’s use of AI and mitigate potential risks to customers and the industry. While federal efforts to promulgate regulations have fizzled out, states have picked up the baton. A recent memo from Goodwin takes a look at the field of regulations for AI use in financial services:

“Artificial intelligence (AI) is increasingly woven into financial services operations, transforming everything from consumer interactions through chatbots and targeted marketing to essential functions like underwriting, credit decisions, fraud detection, fair lending, and collections… as AI adoption accelerates, the question of which agencies will regulate its use remains unsettled…

Neither a consensus nor a binding law on AI regulation at the federal level formed. As the federal momentum faded, state regulators stepped in, passing legislation focused on bias, transparency, and compliance in the use of AI-driven decision-making for lending and employment. Several states also clarified that discriminatory AI behavior would be assessed under their Unfair or Deceptive Acts or Practices (UDAP) laws, creating a patchwork of oversight.”

Currently, California, Colorado, Illinois, Texas, and Utah have laws that regulate the use of AI in financial services, with more proposed legislation in California, Connecticut, Hawaii, and Illinois. The elephant in the room is the federal government’s proposed AI ban as part of the budget reconciliation bill. While the bill passed in the House, its future remains uncertain in the Senate. If passed, The AI ban will bar state regulation of AI for ten years. However, this wouldn’t completely let financial services firms off the hook. As the memo notes, several states are using existing Unfair or Deceptive Acts or Practices (UDAP) laws to tackle AI enforcement. Should the federal ban on AI regulation pass, many states will likely look to laws already on the books to effectively regulate AI.