Outsourcing Risk in Banking Industry

Outsourcing Risk 

The decision to outsource is associated with multiple types of risks, including risks associated with including labor and other process costs. In some cases, risk may not be significant when considered individually; however, but when they interact with other risks areas they may be excessive in the aggregate. Thus, in the end, management’s decision to outsource to reduce certain risk exposures may ultimately increase the entity’s total portfolio of the bank.

The decision to outsource may create risks to an entity’s strategy and market, operation, finance, human capital, IT, legal/compliance, and reputation, for example, consider the following risk areas that may be affected by outsourcing:

1.      Strategic Risks: Strategic risks can arise from adverse business decisions and may result in adverse effects to earnings or capital. Not choosing the right service provider may result in unnecessary costs to the bank. In addition, the bank may fail to implement appropriate oversight of the provider or lack adequate expertise and may not be able to recognize and manage problem caused by the provider.

2.      Reputation Risk: Reputation risk can result from poor service from third-parties or from customer interaction that is not consistent with the overall standard of the bank some time third-party practices and activities may not be in line with the bank’s practices or desired image.

3.      Compliance Risk: When consumer or legal compliance controls are in adequate, or if an outsourced provider has inadequate control system in place, compliance risks may occur.

4.      Operational Risk: Operational risk may result from technology failure, inadequate financial capacity to fulfill obligations or provide remedies, and or error. Outsourcing parties of the supply-chain process to the lower quality vendors may hinder production and delivery.

5.      IT Risk: With many outsourcing arrangement dependent on the internet access, any breakdowns in connectivity and the need for an adequate IT infrastructure may create risks.

Risks factors associated with  IT outsourcing

6.      Legal / Regulatory Risk: Legal issues related to privacy, confidentiality, and security of business transactions may increase.

The bank management should follow appropriate risk management approach so as to bring risks, with in an acceptable level for key entity stakeholders, including shareholders. The risks management toll should identify, assess, and respond to all the significant risks associated with outsourcing decisions. It is important for the banks while outsourcing any of their activities to ensure that business continuity plans are in place which is to be followed in the event of default by the outsourcing vendor to fulfill its obligations under the outsourcing agreement. Risk mitigation strategies should be followed on a regular basis for managing outsourcing arrangement.

Conclusion:

To-insource or outsource is a strategic decision for many 21^st century organizations, including banking sector. Out sourcing the core or non-cor activities is a strategic decision for bank, as it can affect the quality and cost of services to outsource is associated with multiple type of risks. Therefore, appropriate risk mitigation strategies should be followed in a regular basis for managing out sourcing arrangements.

(Reference: This Article from the journal of the ICAN and written by CA, LD Mahat. He is a fellow member of ICAN)