No. 2210

WEDNESDAY, OCTOBER 20, 1999

NEW YORK FED STUDY CITES BEST PRACTICES FOR OUTSOURCING

NEW YORK -- The Federal Reserve Bank of New York today released a study of the practices used by financial institutions to mitigate risk associated with the use of third-party service providers, also known as "outsourcing."

Although financial institutions have outsourced activities such as payroll processing for years, such activities have grown to include information technology, accounting, auditing, electronic funds transfer, investment management, and human resources, according to the study.

According to published reports cited in the study, total global expenditures on outsourcing by financial institutions were $180 billion in 1997 and $235 billion in 1998, with expenditures expected to exceed $300 billion by 2001.

The study provides an overview of the risks financial institutions may face when using third party service providers and was designed to help financial institutions mitigate outsourcing risk by providing a benchmark for industry best practices.

According to the study, several factors unique to outsourcing give rise to potential operational, legal and reputational risks for financial institutions using third-party service providers, among them:

  • binding contractual relationships with another legal entity, typically an unaffiliated third party;
  • giving third parties access to confidential data, strategic technology applications, or the books and records of the institution;
  • problems of the service provider that may become problems for the client financial institution;
  • changes in the financial institution’s business practices and processes; and
  • potential dependency on the third-party service provider.

The study identifies industry sound practices for managing these arrangements and discusses potential concerns for supervisors and regulators.

The supervisory assessment of outsourcing risk at a financial institution, according to the study, ultimately depends on the size and nature of the service provided, how effectively the institution manages, monitors and controls outsourcing risk, and how well the service provider manages its inherent risk.

The study was produced by surveying a cross-section of financial institutions in the Federal Reserve’s Second District. Financial services institutions, service providers, management and process consultants, lawyers and academics from around the country also participated in the study.

The study was written by Kausar Hamdani, assistant vice president, Joseph Galati, examining officer and Patrick Prickett, senior financial analyst of the New York Fed.
Outsourcing Financial Services Activities: Industry Practices to Mitigate Risks
24 pages/108kb