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The Rise of Outsourcing

By Michael Wilson, CTO, Community Bank

Outsourcing in the banking industry is on the rise. From account solutions and core banking systems to research and analysis, businesses are looking to outside organizations for expertise rather than building a team internally. In fact, according to the World Retail Banking Report, 77 percent of retail banks outsource at least one part of their business.

"Increased reliance on outsourcing impacts the ability of regulated financial services organizations to manage risks and monitor compliance with regulatory requirements"

This is fairly new trend—outsourcing only became formally identified as a business strategy in the late 1980s with the profound leap in internet technology and software. Most recently, outsourcing has been rebranded as “cloud,” making it seem new and fashionable.

So what caused this dramatic leap within the past decade?

Reasons to Outsource

Financial practicality: For some organizations, especially smaller institutions, it makes fiscal sense to outsource. Upfront costs associated with purchasing hardware and software can be cumbersome, on top of having to pay for yearly maintenance. Outsourcing can drastically reduce these initial costs—common industry estimates show it provides banks with a savings of 20 to 40 percent, depending on whether processes are located locally or abroad.

Specialized expertise: If financial institutions don’t have teams with a specific knowledge, outsourcing is the natural and easy answer. For example, core banking systems are commonly outsourced due the high level of expertise needed.

Simplicity: Outsourcing takes away the heavy lifting and headaches IT functions can cause. For executives, this can be a big draw of outsourcing, saving their companies time and money.

Are Keeping Functions In-House Obsolete?

When examining the benefits of outsourcing, it’s easy to wonder if institutions will soon outsource all functions. Not to mention that when functions are outsourced, it can seem like an enormous undertaking to switch to in-house capabilities. More often than not, financial institutions can’t even fathom doing so and as a result choose to maintain the status-quo.

However, all financial institutions sit on a spectrum— organizations like BankOne, now JPMorgan Chase, outsourced nearly all technology in the mid-1990s only to bring it back in-house, while others, such as Community Bank N.A., outsource only a few functions. Personally, I have experienced both ends of the spectrum and even worked to bring outsourced functions in-house. While outsourcing does have numerous benefits, it also presents challenges and can reach a point when it is no longer financially beneficial for an organization.

The Risks of Outsourcing

Increased reliance on outsourcing impacts the ability of regulated financial services organizations to manage risks and monitor compliance with regulatory requirements.

A number of years ago, a regulator told me that I would never achieve a top rating as long as I was outsourcing. The reason being, that outsourcing places the security of customers in the hands of vendors and out of our control. They not only control an organization’s security and customer information, but also influence financial strength, marketplace reputation and so much more. Regulators have since reacted to the outsourcing trend by placing a great emphasis on having a robust vendor management program.

As a result, when using outsourcing, there is a higher burden placed on vendor management, monitoring and documenting. While this is still very important when functions are completed in-house, it becomes crucial with outsourcing. Therefore, outsourcing is not possible without a strong vendor management program that assesses vendor risk and maintains close oversight and scrutiny of high-risk vendors. In fact, due to the level of control vendors hold, all outsourcing vendors should be viewed as high-risk. In the end, it becomes a trade-off between relying on your own security controls and managing a vendor relationship.

In addition to vendor management, a high emphasis should be placed on initial contract with vendors. Most vendor contracts are priced based upon a measurable item, such accounts or transactions. It’s important to negotiate contracts with growth-based pricing controls, which return some leverage back to you, the customer. Otherwise, these outsourced arrangements typically benefit the vendor. In addition, it’s equally important to negotiate exit terms to the contract that are beneficial for your company, as many times vendor contracts have exit terms that benefit only themselves.

The Future of Outsourcing

The natural order of the world is cyclic. You’ve heard the phrase before—what’s old is new and new is old. Cycles can be seen in everything: fashion, music, health trends and even outsourcing. Twenty years ago, there were service bureaus; now we’ve rebranded outsourcing to the cloud.

It’s inevitable that at some point an organization will cause a disruption and offer all in-house functions to set themselves apart from the competition; however, looking into the near future, outsourcing is here to stay. It presents mutual benefits for both parties too great to be ignored, and organizations are thriving in the current model. The key is for financial institution leaders to stay updated and educated about current trends and technologies available, and actively assess what will best support their goals.

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