We are living in a constantly changing business environment. Intense competition, coupled with the technological revolution, has created opportunities for business firms to outsource certain activities. Businesses gain a competitive advantage as a reward of new technology adoption, economies of scale (and scope), wide coverage of global markets, frequent product changes and quality and timely resolution of customer needs. Organisations outsource either to reduce cost or to overcome a limitation of not having the requisite expertise to perform a task. Thus, outsourcing equips firms to slash costs and hone their core competencies. Clearly, by its very nature and benefits, outsourcing is not only restricted to industry. Even the financial world is much into outsourcing activities like investment management, marketing and research, data processing, security, and housekeeping, to name a few. However, outsourcing a task is far more complex than it is considered when it is done by financial institutions, especially banks. The exposure of banks to outsource activities is not free from hazards. Disbursement of loans on the names of fake employees, misuse of IT infrastructure to steal customers’ details, lesser amounts disbursed by ATMs or frauds happening because of involvement of call centres are classic examples of frauds related to outsourcing activities by banks. RBI as a regulator has expressed its concerns over such frauds and is much concerned about the risks to which banks are exposed to due to outsourcing, and hence has formulated important guidelines for the same. This article provides a more comprehensive overview of the different types of risks that banks face because of their outsourcing decisions. It also aims to bring forth the major RBI guidelines in this regard.


Outsourcing in banks


Despite heightened competition and alliances, ever-changing regulatory settings, and rapid technological progressions, the Indian banking sector has witnessed robust growth. This shifting landscape in the banking industry is resulting in banks to discover outsourcing possibilities to reach efficiencies. A commonly understood reason for outsourcing is that banks have significantly reduced their exposures to non-core activities and focus on relative ‘core’ activities to gain competitive advantage. RBI defines outsourcing as, ‘Use of a third party by banks to accomplish the activities on an ongoing basis that would normally be assumed by the bank itself, now or in the future’. While outsourcing has become a typical practice in banks, it has also resulted in more severe challenges like ensuring service quality, monitoring of outsourced processes, and compliance with the regulatory requirements. This is the reason; opinions diverge on the risk-return trade-off related to outsourcing by banks. Risk of outsourcing is a matter of concern and needs a careful examination. Risks that banks are exposed to due to outsourcing are many, with operational risk, reputational risk, strategy risk, compliance risk, and country risk, to name a few. The inability of a service provider in delivering a specified service, a breach in safety / privacy, or non-compliance with legal and regulatory requirements by either the outsourcing bank or the service provider does not only result in financial losses / reputational risk for the bank; but could also result into systemic risks for the entire banking system in the country. Thus, outsourcing banks should gear up and ensure controls to be in place to mitigate the above-mentioned risks. Therefore, banks at all time should be proactive and in preparedness to avoid losses due to these risks.

To read more, please subscribe.