RBI orders cooperative banks not to outsource basic management

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The Reserve Bank of India on Monday ordered cooperative banks not to outsource basic management functions such as policy formulation, internal audit and compliance, compliance with KYC standards, credit sanctions and enforcement. management of the investment portfolio.

In issuing guidelines for risk management in the outsourcing of financial services by cooperative banks, the central bank said lenders can hire experts, including former employees, on a contractual basis subject to certain conditions. conditions.

Outsourcing is defined as the use of a third party to perform activities on an ongoing basis that would normally be undertaken by a cooperative bank itself, now or in the future. The “continuous basis” would include agreements for a limited period.

Co-operative banks increasingly resort to outsourcing as a means of reducing costs as well as benefiting from specialized expertise, where this is not available internally.

Although it is entirely the prerogative of banks to decide whether to outsource an authorized activity taking into account all relevant factors, including the business aspects of the decision, such outsourcing exposes banks to various risks. , said the RBI.

“However, cooperative banks that choose to outsource financial services should not outsource basic management functions, including policy formulation, internal audit and compliance, compliance with KYC standards, credit and investment portfolio management, ”the guidelines say.

The guidelines, the RBI said, were issued to allow cooperative banks to put in place the necessary safeguards to deal with the risks inherent in outsourcing activities.

They were asked to self-assess their existing outsourcing arrangements and bring them into line with these guidelines within six months.

In accordance with the guidelines, the outsourcing of any activity by a cooperative bank does not diminish its obligations and those of its board of directors and CEO as well as management, who have ultimate responsibility for the outsourced activity.

A cooperative bank intending to outsource any of its financial activities will have to put in place a comprehensive outsourcing policy, approved by its Board of Directors, in accordance with the criteria set out in the guidelines.

The main risks indicative of outsourcing that should be assessed by cooperative banks include strategic risk, reputational risk, compliance risk, operational risk, legal risk, exit strategy risk and country risk.

In addition, the terms and conditions governing the contract between a cooperative bank and a service provider should be carefully defined in written agreements and verified by the bank’s legal advisor on their legal effect and enforceability, as directed.

In addition, in order to mitigate the risk of unexpected termination of the outsourcing arrangement or liquidation of the service provider, cooperative banks should maintain an appropriate level of control over their outsourcing and the right to intervene with appropriate measures. , to continue their business activities in such.

If a service provider’s contract is terminated prematurely before the end of the contractual service period, the Indian Banking Association (IBA) should be notified of the reasons for termination. IBA would maintain a cautionary list of these service providers for the entire banking industry to share among banks.

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