Emerging Trends and Challenges in Third-Party Risk Management for Financial Institutions

Emerging Trends and Challenges in Third-Party Risk Management for Financial Institutions

Third parties are playing an increasingly vital role in the financial industry, as financial institutions (FIs) look to adopt technology and services from external providers to enhance their competitiveness and drive innovation. However, this growing reliance on third parties also brings forth a set of challenges and risks that FIs need to address effectively. In this article, we will explore the emerging trends and challenges observed in third-party risk management (TPRM) for FIs.

Growing Reliance on Third Parties

FIs are increasingly turning to third-party technology and services to improve their operations and gain a competitive edge. This reliance on external providers has become a prevalent trend in the financial sector, as FIs seek to leverage the expertise and capabilities of third parties. By partnering with technology-based service providers, FIs can access advanced solutions and innovations that may be beyond their in-house capabilities.

However, this growing reliance also introduces a level of dependency on third parties. FIs must carefully evaluate the risks associated with outsourcing critical activities and ensure that appropriate measures are in place to mitigate these risks. They need to establish robust vendor management processes to monitor and assess the performance and security of their third-party providers.

Increased Regulatory Scrutiny

Regulators worldwide are placing greater emphasis on effective TPRM practices within the financial industry. Recent interagency guidance in the United States, for example, has called for financial institutions to apply specific principles throughout the lifecycle of their third-party relationships. The focus on “resiliency as a supervisory priority” highlights the need for FIs to thoroughly review their outsourced critical activities and implement measures to maintain operational resiliency.

As regulatory scrutiny intensifies, FIs must ensure compliance with the evolving standards and guidelines. They need to establish robust due diligence processes to assess the risks associated with third-party providers, implement effective monitoring mechanisms, and have contingency plans in place to address any disruptions or breaches that may occur.

Increased Third-Party-Caused Disruptions and Reputational Damages

Third-party incidents can have significant consequences for FIs, including disruptions to operations, financial losses, and reputational damage. According to a recent survey conducted by KPMG, 72 percent of financial institution respondents reported experiencing significant disruption, monetary loss, or reputational damage due to a third-party incident within the past three years.

For example, a cyberattack on a software vendor can lead to a system outage, impacting the FI’s ability to serve its customers and potentially exposing sensitive data. FIs need to strengthen their resilience against such incidents by implementing robust cybersecurity measures, conducting regular audits of their third-party providers’ security controls, and having incident response plans in place to mitigate the impact of any potential breaches.

Limited Resources

With economic uncertainties and cost pressures, many FIs are reducing spending on TPRM programs. However, as the scope of TPRM expands and the risks associated with third parties become more complex, FIs need to ensure they have adequate resources and capabilities to effectively manage these challenges.

Investing in TPRM capabilities is crucial for FIs to enhance their risk management practices and protect against potential vulnerabilities. This includes allocating sufficient resources to conduct thorough due diligence, ongoing monitoring, and periodic assessments of their third-party providers. FIs should also consider leveraging technology solutions to streamline and automate their TPRM processes, enabling them to manage a larger number of third-party relationships efficiently.

Expanded Universe of Third-Party Risks

The third-party risk landscape has become increasingly complex, presenting FIs with new and evolving risks. Cybersecurity, in particular, has emerged as a critical area for TPRM, with the rising number of data breaches compromising FI data and customer trust. FIs need to prioritize cybersecurity measures and ensure that their third-party providers have robust security controls in place.

In addition to cybersecurity, FIs are also facing challenges in integrating environmental, social, and governance (ESG) risks into their TPRM frameworks. As sustainability becomes a global priority, FIs need to assess the ESG risks associated with their third-party relationships and ensure that their providers align with their sustainability goals.

Furthermore, FIs are increasingly recognizing the importance of assessing nth parties, beyond their immediate contracting party, to identify potential sanctions and concentration risks. This expanded view of third-party relationships allows FIs to have a more comprehensive understanding of the risks involved and implement appropriate risk mitigation strategies.

Conclusion

As financial institutions continue to rely on third parties for technology and services, effective third-party risk management becomes paramount. FIs must stay abreast of the emerging trends and challenges in TPRM and proactively address them to safeguard their operations, reputation, and customer trust. By investing in robust TPRM capabilities, allocating sufficient resources, and leveraging technology solutions, FIs can navigate the complex third-party risk landscape and ensure resilience in an increasingly interconnected financial ecosystem.