Federal Reserve Issues Guidance Reminding Banks of Responsibility for Actions of Outside Vendors
On December 5, 2013, the Federal Reserve released guidance reminding banks within its supervisory jurisdiction of the need to exercise appropriate risk management and oversight when outsourcing to third-party service providers. The Fed made it clear that banks will be held responsible for any violations of law committed by service providers. The Fed broadly defined “service providers” to include all entities that have entered into contractual relationships with a financial institution to provide business functions or activities, such as accounting, auditing, loan review, compliance, and risk management.
Banks often outsource these activities for cost reasons, or because the third party service providers have a higher level of expertise. While the guidance did not discourage banks from outsourcing, it did describe different types of risks that come along with the practice. In a press release, the Fed said, “[f]inancial institutions are responsible for ensuring that all activities conducted by service providers comply with applicable laws and regulations and are consistent with safe and sound banking practices.”
The Fed encouraged financial institutions engaging in relationships with service providers to institute risk management programs. Effective risk management programs include the following core elements: risk assessments; due diligence and selection of service providers; contract provisions and considerations; incentive compensation review; oversight and monitoring of service providers; and business continuity and contingency plans. The guidance is applicable to all financial institutions that are regulated by the Federal Reserve System, regardless of size.
Practical Impact
The Fed’s guidance comes on the heels of similar statements by other regulators. For example, the Office of the Comptroller of the Currency issued a similar statement to the national banks and federal savings associations under its supervision just under a month ago. The OCC’s guidance highlighted the importance of due diligence and conflict-of-interest checks for vendors. At a minimum, under the OCC and Fed guidance, banks will be imposing greater qualification requirements, more paperwork, more oversight, and more responsibility on their vendors. Therefore, not only banks but also companies that provide services will feel the impact of this increased regulatory scrutiny.
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