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Outsourcing Financial Services Activities: Industry Practices to Mitigate Risks

One of the unique f iscal agency functions that the Reserve Banks provide to the Treasury is a program through which the Reserve Banks invest Treasury monies until needed to fund the government’s operations. The Treasury receives funds from two principal sources: tax receipts and bor- rowings. The funds that f low into and out of the government’s account vary in amount throughout the year; for example, the account balance tends to be relatively high during the April tax season. The Treasury directs the Reserve Banks to invest funds in excess of a previously agreed- upon minimum amount in. | Outsourcing Financial Services Activities Industry Practices to Mitigate Risks Federal Reserve Bank of New York October 1999 Outsourcing Financial Services Activities Industry Practices to Mitigate Risks I. MANAGEMENT OVERVIEW Outsourcing or the use of third-party service providers is a business strategy that is being considered more frequently by financial institutions as they respond to an increasingly competitive marketplace. While not new many of the activities currently being outsourced such as information systems business processes and internal audit 1 are integral to the functioning of the organization vital to supporting core businesses and create dependencies upon service providers. Given the scale and prevalence of these types of arrangements outsourcing raises potential supervisory concerns. Outsourcing arrangements present four key challenges which if not addressed adequately introduce significant risks for the financial institution. While other risks exist and are discussed in this paper the primary concerns are Selecting a qualified vendor and structuring the outsourcing arrangement - Failure to choose a qualified and compatible service provider and to structure an appropriate outsourcing relationship may lead to on-going operational problems or even a severe business disruption. These events may result from service provider employees not having the necessary skills or familiarity with the industry or from service providers lacking an adequate technical capacity or financial stability. The contract needs to clearly articulate the structure of the outsourcing arrangement and the expectations of both sides otherwise excessive amounts of management time may be consumed with dispute resolutions or with managing a contentious relationship. Managing and monitoring the outsourcing arrangement - As management focus shifts from direct to indirect operational control over an activity there is a risk that undue reliance may be placed upon the service provider by