Regulators are raising alarms about banks’ increasing use of third-party vendors and contractors. A recent Federal Reserve report criticized banks for relying on outside companies without adequately vetting or monitoring the relationships. The regulators warned that this could threaten data security, cause operational issues, and even lead to substantial financial loss.
Regulations Of Third-Parties Set Expectations
The Fed issued new guidance outlining principles for banks to improve oversight of third parties like fintech startups. While the direction provides valuable advice, some argue it may be an overcorrection that reduces banks’ willingness to work with outside firms.
On the one hand, the regulators have a point. Banks have become heavily dependent on outsourcing critical functions to third parties they barely understand or oversee, the regulators said. Some companies even outsource to other subcontractors, creating a tangled web. Regulators caught banks failing to assess third parties or hold them accountable.
However, the new regulatory guidance is not merely a set of recommendations. Although not legally enforceable, it establishes expectations that banks feel pressure to meet to avoid penalties. The broad principles will require extensive work to translate into actionable policies and processes for each bank’s unique needs. And additional rules may still be necessary to address outsourcing risks in data use, lending, and Banking-as-a-Service areas.
Compliance Is Key
While providing helpful clarity, the added scrutiny and compliance burden could curb banks’ appetite for partnerships in the short term. Small banks, in particular, may struggle to implement the guidance due to limited resources. Fintechs would likely need to do more to reassure banks of their compliance.
What’s Next For Third-Party Risk Management?
In summary, regulators have raised significant concerns about banks’ third-party risk management practices that demand attention. But the new guidance and any subsequent rules will also create challenges, especially for small banks and fintech. Managing relationships with outside firms is becoming increasingly crucial and complex in the digital era. Banks will need to strike a balance, relying on third parties to drive innovation while mitigating financial system risks. Overall, closer collaboration and transparency between banks, regulators, and their partners will be vital to achieving this balance.
