The Reserve Bank of India released guidelines for co-operative banks to manage risks that will arise from the outsourcing of financial services. The Reserve Bank stated that the Chief Executive Officer and the senior management of the co-operative banks shall be responsible for evaluating risks and the materiality of all existing as well as prospective outsourcing activities. Outsourcing of financial services by co-operative banks: Objective of the guidelines The RBI said that the underlying principles behind issuance of these guidelines are that the co-operative bank must ensure that outsourcing arrangements neither diminish its ability to fulfil its obligations to customers and the Reserve Bank, nor impede effective supervision by the Reserve Bank of India/National Bank for Agriculture and Development. Further, these guidelines will not apply to technology-related issues. Essential Guidelines by RBI on Outsourcing of financial services by co-operative banks The Reserve Bank mentioned that a bank would retain the ultimate control of outsourced activities. Co-operative banks shall now have to conduct a self-assessment of their existing outsourcing arrangements and bring their current outsourcing arrangements in line with the guidelines issued within six months. The regulator has also specified that co-operative banks will be responsible for the actions of their service provider, including actions of business correspondents and their retail outlets/sub-agents. The mechanism of grievance redressal of co-operative banks must not be compromised on account of outsourcing. Co-operative banks are also required to put in place a management structure in order to monitor and control outsourcing activities. The indicative key risk in outsourcing that has to be evaluated includes the following: Strategic risk;Reputation risk;Compliance risk;Operational risks;Legal risk;Exit strategy risk;Counterparty risk;Contractual risk;Country risk;Concentration and systematic risk. A co-operative bank that seeks to outsource any of its financial activities will have to place a comprehensive outsourcing policy approved by that board. In case the contract of the service provider is terminated prematurely before the completion of service, the Indian Banks’ Association (IBA) will have to be informed with reasons for such termination. The Indian Banks’ Association would be maintaining a caution list of such service providers for the entire banking industry for sharing among banks. RBI specified that the board and CEO as well as the Senior Management will be ultimately responsible for outsourcing operations and to manage risks inherent in such outsourcing relationships. Further, the cooperative banks must undertake appropriate due diligence to assess the capability of the service provider to comply with the obligations in the outsourcing agreement. The Reserve Bank emphasised that the cooperative banks that decide to outsource financial services, however, must not outsource core management functions, including policy formulation, internal audit & compliance, compliance with the KYC norms, credit sanction, and management of the investment portfolio. However, where needed, experts, including the former employees, can be hired on a contractual basis subject to the Audit Committee of Board (ACB)/Board being assured that such expertise doesn’t exist within the audit function of the bank. Any conflict of interest in such matters will be recognised and addressed effectively. The Ownership of audit reports in all cases will rest with regular functionaries of the internal audit function. During inspections or scrutiny, the RBI / NABARD shall review the implementation of these guidelines in order to assess the quality of the related risk management systems, particularly in respect of material outsourcing. Conclusion While issuing the guidelines for managing risk in outsourcing financial services by the cooperative banks, the RBI said that the lenders can hire experts, including former employees, on a contractual basis but subject to certain conditions. Outsourcing of financial services is defined as the use of a third party to carry out activities on a continuing basis. Read our article:Why is Virtual Chief Financial Officer growing in recent times?