Global supply risks

Outsourcing Challenges for Indian Banking Sector

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“If you deprive yourself of outsourcing and your competitors do not, you’re putting yourself out of business.”– Lee Kuan Yew, Former Prime Minister of Singapore

Outsourcing has become an extremely popular business formula in the highly competitive world, over the past decade. It is a business strategy, through which an organization contracts out key tasks to service providers, for achieving a business solution. In the present era, every other sector leverages outsourcing policies in some form or the other. The financial and banking sector is also not lagging behind. Amplifying competition in the banking sector has compelled banks to outsource some of their activities.

In 2005 the Reserve Bank of India (RBI) drafted the ‘Outsourcing’ policy which mentions the usage of third party in the Indian banking sector. This ‘third party’ is defined as either an associated body within a corporate group or an external entity, which can execute operations on a continuing basis. By outsourcing activities, banks can shrink its risk by assigning activities to others with better capabilities and scale to manage the associated risk. Since then, the Indian banks have started outsourcing their services to be on the top of the race. This blog concentrates around the outsourcing challenges faced by Indian banks and what measures can be taken to avoid it.

Indian banks mostly outsource non-core services.  This includes conserving and managing of software and hardware, maintaining data centers, supporting software application, disaster management and smooth execution of ATM networks across the country.  Non-core support services such as help-desk support, call-support services, credit card processing, ATM Cash replacement, loan servicing, data mining, etc., are taken care of through outsourcing. Lately, Axis Bank has outsourced its technical services. Often a team of professionals looks after the performance of ATM from a distant center and externally supports the banks through their domain expertise. The public sector banks of India are also not untouched by the policy of outsourcing. Bank of India (BoI) signed an outsourcing contract with India Switch Company in 2002. State Bank of India (SBI) outsources its networking services of ~1,500 branches and ~3,000 ATMs to Data craft. Similarly, Yes Bank, a private bank has signed an outsourcing deal with Wipro InfoTech. Thus, Indian banks outsource in order to enhance efficiency by reducing cost, and focus more on core banking. Indian banks save around 30-40% through outsourcing compared to any other captive outsourcing units.

The Challenges:  

With the increasing outsourcing activities in the Indian banking sector, there lies inherent risks that needs to be identified and requires attention for risk mitigation.  A huge section of banks creates in-house working center, known as Captive BPO’s. These Captive BPOs are like small firms that create their own delivery center internally at a fixed cost. The first and foremost risk associated with such a process is security. There must be a complete security mechanism to deal with the huge amount of data that are available with them. Over reliance on such centers can lead to leakage of important information and eventually, loss of control over the business.  Insufficient knowledge to supervise the service provider, poor service from the third party, third party practices not in line with listed bank practices, operational risk from the service provider’s end, insufficient financial capability to fulfill requirements, inappropriate credit assessments, are some of the most commonly associated risks. Additionally, political, social climate and complex business continuity planning bring out further challenges.

The Solution:

To overcome the challenges, the banks should not enter into an agreement with the service provider where there might be a clash of interests. Adequate control over the service provider is highly essential. Crucial activities which includes, account opening, sanctioning loans, investment portfolio management, should never be outsourced. The bank should ensure that the service provider does not leak information or data such as asset records, deposits and withdrawals. A service provider or third party should not have a stake in the bank. Additionally, the senior management should be bestowed with powers to evaluate the risks involved in outsourcing and a board should be responsible for its approval. The board should intermittently review the outsourcing arrangement and keep a check on its relevance. The capabilities of the service provider should be evaluated and made sure that they match the expected standard of the bank. The third party should only be involved after sufficient research. It is advisable not to let the concentration of outsourcing activities with a single provider by a large number of banks.  Finally, due diligence along with adequate legal help is required for drafting the contract with the third party.

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