The critical need for enhanced third-party risk management

As regulatory scrutiny intensifies, banks and credit unions and their service providers are under increasing pressure to enhance their third-party risk management strategies. The growing reliance on external vendors for critical services has made third-party risk a focal point of regulatory examinations, driving the need for proactive and comprehensive risk management frameworks.

The expanding scope of regulatory oversight demands that banks and their service providers significantly bolster their risk management, governance and control operations. Regulatory bodies are increasingly focused on how financial institutions manage their third-party relationships, particularly in terms of operational resilience and the capacity to withstand and recover from disruptions. To meet these expectations, banks must align their operations with supervisory rules, identify vulnerabilities in their third-party engagements and establish actionable strategies to mitigate potential risks.

The emphasis on third-party risk management goes beyond mere compliance; it is about building a sustainable and resilient ecosystem that can support customer services, maintain revenue streams and ensure robust regulatory controls. Banks must integrate supervisory guidance, such as the Third-Party Risk Management and Operational Resilience frameworks, into their operations. This integration is essential for creating a resilient business environment that can adapt to evolving regulatory expectations.

Building a credible, risk-sensitive framework

From my experience as an examiner and senior policymaker at the FDIC, banks that develop well-constructed, practical plans for managing third-party risks are better equipped to maintain operational stability and mitigate potential disruptions — and they will build credibility with examiners. This credibility is crucial, as it reflects the institution’s understanding of the complexities involved in managing outsourced functions and its commitment to maintaining regulatory standards. Conversely, banks and credit unions that attempt to demonstrate full compliance without adequately addressing potential risks often encounter skepticism and face more stringent reviews.

Developing a risk-sensitive framework that allows for flexibility and adjustments is essential for responsibly managing third-party risks and ensuring the long-term stability of the institution. Such a framework acknowledges the inherent challenges of relying on third-party vendors and focuses on managing, rather than eliminating risks. This approach is generally perceived as more realistic and credible by regulators, as it demonstrates a deep understanding of the dynamic nature of third-party risks.

The importance of contingency planning

A business plan that appears flawless on the surface but lacks robust contingency strategies for potential vendor exits or adjustments invites deeper scrutiny from regulators. Before asserting the completeness of their third-party risk management practices, banks should reassess their new business activities from multiple perspectives. This reassessment ensures that the bank is not only prepared for current regulatory inquiries but is also equipped to handle unforeseen challenges in the future.

Effective third-party risk management is not just about compliance; it is about protecting the bank’s reputation, ensuring continuity of business operations — and ultimately, doing the right thing for clients and other stakeholders. Comprehensive preparation for examinations is critical, as the bank’s ability to thoroughly explain its operations and third-party relationships can significantly influence the outcome of the review. Inadequate preparation can lead to broader criticisms from regulators, potentially impacting both the bank and its vendors.

Adopting a risk-based approach

Regulators have increasingly adopted a risk-based approach to third-party management, recognizing that not all external relationships pose the same level of risk. This flexibility allows banks to tailor their third-party risk management strategies according to their size, complexity, and specific risk profile. However, this approach requires that banks conduct periodic risk assessments— at defined frequencies — for each of their external relationships to ensure that they remain aligned with regulatory expectations.

The key to achieving regulatory compliance and operational resilience also lies in a bank’s ability to effectively engage with its examination team. Banks that proactively identify potential challenges and present well-considered solutions are generally more successful in their examinations than those that passively comply with regulations without fully understanding their implications.

Internal assessments and preparatory discussions

Before seeking external guidance, bank leadership must conduct a thorough internal assessment of their reliance on third parties. This internal assessment should involve diverse viewpoints within the organization, ensuring that all potential risks are considered. By engaging in these preparatory discussions, banks can build a consensus that aligns with both regulatory expectations and their business objectives.

Assessing the risks associated with specific activities or partnerships involves careful consideration of various factors, such as the third party’s access to sensitive data, transaction processing capabilities, and the provision of critical technology and business services. These assessments should be supported by extensive discussions across departments, from operations to technology, to ensure that all aspects of the third-party relationship are thoroughly evaluated.

Investing in these preparatory discussions is essential for building a robust third-party risk management strategy. This investment not only aids in navigating upcoming regulatory examinations more smoothly, but very importantly enhances the overall resilience and reliability of the bank’s operations. Ultimately, a well-prepared bank is better positioned to achieve long-term stability and maintain regulatory compliance, safeguarding its reputation, protecting its stakeholders and ensuring continued success in an increasingly complex regulatory environment.

Jason Cave, a former FDIC examiner, is Strategic Advisor for Regulatory and External Relations at R&T Deposit Solutions.