Many banks use a third party to perform certain activities that would have been normally performed by the banks themselves. They outsource some activities to a party, which may or may not be affiliated with the outsourcer bank. Outsourcing of financial services is a broad based activity that includes processing of loans at the original stage, credit card processing, document processing, marketing and research, supervision of loans, data processing and back office activities.
The banks are exposed to many risks while outsourcing. The interests of the bank's customers should never be compromised. The reputation of the banks and their financial wellbeing are at stake. Hence, while outsourcing financial services, banks have to understand these risks and make conscious efforts to manage them effectively.Strategic Risks:
Every bank operates with some strategic long and short time goals. The service provider should relate to these goals and strengthen efforts to achieve them. If the service provider conducts business on its own and in variance with the strategic goals of the bank, it would mean trouble for the bank.Reputation Risks:
The very idea of outsourcing is to provider better service to customers. The service provider should be conscious of the standards set by its client in dealing with customers.Compliance Risks:
Prudential laws, consumer and privacy laws are the foundation for good banking. The service provider may not act in accordance with these laws.Operational Risks:
Failure of technology, fraud, inadvertent errors on the part of the service provider, and most of all the failure of banks to fulfill the obligations of their customers by providing remedies represent a grave risk to banks.Legal Risks:
The errors on the part of service provider deliberate or not, may result in legal action in the form of fines, penalties, punitive damages, as well as compensatory settlements by the banksExit Strategy Risks:
Over-dependence on a single service provider is not a good idea. The bank cannot acquire and nurture relevant skills within. Even if the bank wants to get out of such a rut, it cannot do so as it may turn out to be an expensive proposition. The bank is stuck with its outsourcing partner.Counter party Risks:
There is always a risk of the service provider not making correct credit assessments or of underwriting them.Country Risks:
This is a risk that common with off shore outsourcing. The political, social, cultural and legal set up of the country in which the service provider is located plays a crucial part in the success of outsourcing. Since these are not static and often unpredictable, the risk is more critical.Contractual Risks:
This risk is possible when a bank is unable to enforce the contract entered between the bank and the service provider.Concentration and systemic Risks:
In certain cases, all the banks of a country or region have a single common service provider. In such a situation, the individual bank may not be able to control the service provider.
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