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An institution's board of directors and senior management are ultimately responsible for managing activities conducted through third-party relationships, and identifying and controlling the risks arising from such relationships, to the same extent as if the activity were handled within the institution.
For purposes of this guidance, the term "third party" is broadly defined to include all entities that have entered into a business relationship with the financial institution, whether the third party is a bank or a nonbank, affiliated or not affiliated, regulated or nonregulated, or domestic or foreign.
The FDIC recognizes that the use of third parties can assist management in attaining strategic objectives by increasing revenues or reducing costs.
The precise use of a risk management process is dependent upon the nature of the third-party relationship, the scope and magnitude of the activity, and the risk identified.
Financial institutions generally enter into third-party relationships by outsourcing certain operational functions to a third party or by using a third party to make products and services available that the institution does not originate.
Third-party relationships often integrate the internal processes of other organizations with the bank's processes and can increase the overall operational complexity. Transaction risk is the risk arising from problems with service or product delivery.
A third party's failure to perform as expected by customers or the financial institution due to reasons such as inadequate capacity, technological failure, human error, or fraud, exposes the institution to transaction risk.
As the financial services industry continues to evolve, some financial institutions are also using third parties for functions that are either new or have traditionally been performed in-house.Third-party relationships that result in dissatisfied customers, interactions not consistent with institution policies, inappropriate recommendations, security breaches resulting in the disclosure of customer information, and violations of law and regulation are all examples that could harm the reputation and standing of the financial institution in the community it serves.Also, any negative publicity involving the third party, whether or not the publicity is related to the institution's use of the third party, could result in reputation risk. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.Other potential risks arise from or are heightened by the involvement of a third party.Failure to manage these risks can expose an institution to regulatory action, financial loss, litigation and reputation damage, and may even impair the institution's ability to establish new or service existing customer relationships.