Management of Third-Party Risk

Key Insights from the Basel Committee Report

The Basel Committee on Banking Supervision has released a comprehensive document outlining principles for the sound management of third-party risk (TPR) in the banking sector. This consultative document, aimed at enhancing operational resilience and risk management, builds on previous guidelines and reflects the evolving landscape of third-party service provider (TPSP) arrangements in banking.

1. Evolving Dependency on TPSPs:

Banks are increasingly reliant on TPSPs due to the rise in digitalisation and innovative approaches. This dependency extends beyond traditional outsourcing to a broader range of services, necessitating an updated risk management approach.

2. Principles-Based Approach:

The document introduces a principles-based framework for managing TPSP risks, consisting of 12 high-level principles. These principles are divided into guidance for banks (Principles 1-9) and prudential supervisors (Principles 10-12).

”"The principles focus on third-party risk management holistically and are technology-agnostic to keep pace with technological developments. They aim to promote international engagement, greater collaboration and consistency, with a view to reducing regulatory fragmentation and strengthening the overall operational resilience of the global banking system,"
states the Basel Committee report.

3. Comprehensive Risk Management:

Effective TPR management encompasses the entire lifecycle of TPSP arrangements, from risk assessment and due diligence to contracting, onboarding, ongoing monitoring, and termination. Key considerations include:

Governance and Strategy: The board of directors must oversee all TPSP arrangements, ensuring alignment with the bank’s risk appetite and strategic goals.
Risk Assessment: Continuous and comprehensive risk assessment is crucial to identify and mitigate potential risks associated with TPSPs.
Due Diligence: Banks must conduct thorough due diligence on prospective TPSPs to evaluate their capacity, technical ability, and risk profile.
Contracting: Legally binding contracts should clearly define the rights, obligations, and expectations of all parties involved in TPSP arrangements.
Ongoing Monitoring: Regular monitoring and reporting on TPSP performance and risk changes are essential to maintain operational resilience.
Business Continuity Management: Robust business continuity plans (BCPs) should be in place to ensure banks can operate during TPSP service disruptions.

4. Role of Supervisors:

Supervisors play a critical role in assessing banks’ TPR management frameworks, identifying systemic risks, and promoting international coordination to mitigate concentration risks associated with TPSPs.

5. Feedback and Future Refinements:

The Basel Committee invites feedback on the proposed principles by 9 October 2024. This consultative approach aims to refine the guidelines based on industry input and evolving practices.

Implications for Banks and Supervisors:

The principles outlined by the Basel Committee underscore the importance of a holistic and proactive approach to managing third-party risks. Banks must integrate TPR management into their overall risk management frameworks, ensuring comprehensive oversight and resilience. Supervisors, on the other hand, need to enhance their understanding and monitoring of systemic risks posed by TPSPs to safeguard the stability of the financial system.

Conclusion:

The Basel Committee’s principles for the sound management of third-party risk represent a significant step towards strengthening the operational resilience of banks globally. By adopting these guidelines, banks can better navigate the complexities of TPSP arrangements, ensuring they remain robust and resilient in an increasingly interconnected financial landscape.

For more detailed information, please refer to the full Basel Committee report available on the Bank for International Settlements (BIS) website.