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Importance of Outsourcing in Banking Industry Nowadays outsourcing is well practiced in banking industry. The concept of outsourcing is as old as the existence of the human community. With the […]
Nowadays outsourcing is well practiced in banking industry. The concept of outsourcing is as old as the existence of the human community. With the division of labor and specialization of occupation, the core competency has become more narrowly and clearly defined. Further, increase in the complexity of functions necessitated the specialization. Therefore, to in-source or outsource is a strategic decision for many 21st century organizations.
Just like any other industry, Banking is also influenced by the buzzword –outsourcing. Banking and financial services industry across the globe is witnessing robust growth in past few decades. The growth is mainly due to changing regulatory environment, rapid technological advancements, and heightened competition. Banks are forced to consolidate to achieve economies of scale and scope. This changing landscape in the banking industry is driving banks to explore the outsourcing option to achieve efficiencies.
Basel Committee on Banking Supervision has issued guiding principles on “Outsourcing in Financial Services”. The committee has developed set of principles that gives guidance to banks and financial institutions to help better mitigate risks due to outsourcing.
In Nepalese context, Nepal Rastra Bank (NRB) has recognized outsourcing for banks and financial institutions. Such functions include IT functions, internal audit function and other non-core banking functions. Information Technology Guidelines 2012 requires the bank to ensure that outsourcing vendors are capable of delivering the desired level of performance, service reliability, capability and security. Unified Directives 2019 allows the banks to outsource internal audit and hire employees for conducting non-core activities.
Many banks seeking to increase shareholder value outsource to take advantage of a variety of benefits. Such benefits include:
Outsourcing is not free from drawbacks. Such drabacks include:
When considering outsourcing, a common question is which activities should be outsourced and which tasks should be done in-house. Such question may include:
Badly-planned outsourcing could result in erosion of service value and cost escalation. On the other hand, a well-planned outsourcing decision can help bank management to sleep better at night, knowing that the responsibility of deliverables is in safe hands.
Generally, banks divide their activities into core and non-core activities. Core activities being central to their strategy cannot be outsourced whereas the non-core activities can be outsourced.
Banks generally use following decision matrix for effective outsourcing decision:
In outsourcing decision matrix, two important factors are considered in outsourcing a particular function to be performed by a bank. Those factors are:
Strategically important tasks are sources of competitive advantage. Tasks which have a high impact on operational performance are those which, if done well, contribute greatly to the smooth running of the bank. On the other hand, if such tasks are done badly, it may hinder the performance of the bank.
The quadrants of the outsourcing decision matrix are explained below:
Tasks in this quadrant are high in strategic importance, but contribute little to operational performance. Although a bank needs to retain control of them to ensure they are done exactly as it wants, they are relatively insignificant in terms of cost or smooth running. Therefore, such tasks are not worthy of full in-house focus. This means that the bank should form strategic alliance with another competent party.
Tasks in this quadrant are high in strategic importance and have a big impact on operational performance. Banks should keep such tasks in-house to exercise maximum control over these. For example, sanctioning loans is strategically critical task and bank must retain such task in-house.
Tasks in this quadrant are important for successful operational performance, but are not strategically important. Bank could safely outsource such tasks. They’re simply not worth spending in-house. For example, following tasks could be outsourced by a bank:
Tasks in this quadrant are not important to the bank’s overall strategy. Moreover, such tasks do not make a significant contribution to its day-to-day operational performance. Although a bank might not be able to eliminate these tasks completely, it’s important to check why the bank is doing them. Such task include running a subsidized day care center for staff’s children.
The decision to outsource is associated with multiple types of risks, including risks associated with increasing labor and other process costs. In some cases, risks may not be significant when considered individually. But, when they interact with other risk areas, they may be excessive in aggregate.
The decision to outsource may lead to increase in various risks as explained below:
Strategic risk can arise from adverse business decisions and may result in adverse effects to earnings or capital. Bank may incur unnecessary cost by not choosing the right service provider. In addition, the bank may fail to implement appropriate oversight of the provider.
Reputation risk can result from poor service from third parties. Sometimes, third-party practices and activities may not be in line with the bank’s practices.
If an outsourced provider has inadequate control systems in place, this may increase compliance risk.
Outsourcing portions of the supply-chain processes to the lower quality vendors may hinder production and delivery resulting to increase in operational risk.
Many outsourcing arrangements of banks are heavily dependent on Internet access. So, any breakdowns in connectivity and the need for an adequate IT infrastructure may create technology risks.
Legal issues related to privacy, confidentiality, and security of business transactions may increase.
To in-source or outsource is a strategic decision for many 21st century organizations including banking industry. Outsourcing the core or non-core activities is a strategic decision for banks, as it can affect the quality and cost of services and above all the bottom-line. The decision to outsource is associated with multiple types of risks. Therefore, Banks should follow appropriate risk mitigation strategies on a regular basis for managing outsourcing arrangements.
LD Mahat is a Chartered Accountant, Financial Adviser and Risk Management Specialist possessing over 29 years of diverse experience across several sectors covering a wide spectrum of assurance, business advisory and taxation disciplines. LD is a committed, highly motivated and result-oriented professional, consistently developing and nurturing client relationship and building long-lasting relationships with diverse clients. He has the ability to define issues, propose customized solutions that significantly add value and contribute to client’s success.
LD has got master’s in risk management form New York University, Stern Business School. He has undergone executive education at Harvard Business School and Insead Business School. He was risk management specialist in several Asian Development Bank Funded projects. He has provided risk management advisory services in various Nepalese corporate sectors.
LD has worked on large projects jointly with big 4 international accounting firms ~ PwC, Deloittee, Ernst & Young and KPMG in the field of Assurance, Diagnostic Review, Capacity Building, e-Government Procurement, e-Governance, Special Review, Investment Climate, and IFRS Implementation.
