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Best Practices

Fed Issues Guidance for Managing Service Providers

December 12, 2013

The Federal Reserve Board on Dec. 12 released guidance reminding financial institutions to exercise appropriate risk management and oversight when using service providers.

The 14-page document titled "Guidance on Managing Outsourcing Risk," describes factors financial institutions should consider when choosing a service provider and how service providers should be overseen. A service provider is defined as any organization or entity—such as a consultant—that enters into a contractual relationship with a financial institution to provide business functions or activities, such as accounting, auditing, loan review, compliance and risk management.

The Office of the Comptroller of the Currency (OCC) issued similar guidance in November to national banks and federal savings associations for assessing and managing risks associated with third-party relationships. Banks are expected to practice effective risk management regardless of whether the bank performs the activity internally or through a third party, according to the OCC guidance.

The guidance from the Federal Reserve and OCC both echo the message from the Consumer Financial Protection Bureau’s April 2012 bulletin that said lenders need to increase oversight of their service providers and may be held responsible for the actions of the companies with which they contract.

To help lending institutions supplement their risk-management programs, ALTA developed its "Title Insurance and Settlement Company Best Practices” framework. The Best Practices highlight policies and procedures the industry uses to help ensure a positive and compliant real estate settlement experience.

“Mortgage originators are under increased pressure to ensure their third-party service providers are minimizing possible risk and employing business practices that protect all parties during the real estate transaction,” said Michelle Korsmo, ALTA’s chief operating officer. “We agree with the Federal Reserve Board that effective risk-management begins by working with partners that follow proper business practices.

“As financial institutions work to develop their own risk management systems, the land title industry continues to lead with its Best Practices Framework,” Korsmo continued.

The Federal Reserve guidance does not discourage financial institutions from outsourcing activities to service providers, but says firms should be aware of the potential risks. If service provider relationships are not managed effectively, they may expose financial institutions to risks that can damage reputation, and cause financial loss or regulatory actions, according to the guidance.

Use of service providers does not relieve a financial institution of responsibility for the activities performed by service providers, according to the Federal Reserve’s guidance. Financial institutions are responsible for ensuring that all activities conducted by service providers comply with applicable laws and regulations and are consistent with safe and sound banking practices.

The guidance is applicable to state-chartered banks that are members of the Federal Reserve System, bank and savings and loan holding companies and their nonbank subsidiaries, and U.S. operations of foreign banking organizations.



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