Outsourcing policy: Questions and Answers
What is outsourcing?
Outsourcing occurs when a bank uses another party (either a related party or an independent party) to perform business functions that would traditionally have been undertaken by the bank itself. Outsourcing by banks has increased rapidly in the past decade in response to pressures to reduce costs and as communications and information technology have evolved and improved. Common examples of outsourced activities include IT processing, accounting and call centres.
What is the Reserve Bank's outsourcing policy?
The outsourcing policy requires a large bank to have the legal and practical ability to control and execute any outsourced functions to ensure that it has the ability to continue to provide core liquidity, payment and transaction services in the event that one of its service providers fails or becomes dysfunctional, or if the bank itself fails.
Is the Reserve Bank against outsourcing?
The Reserve Bank is not against outsourcing per se, and recognises that well-designed outsourcing arrangements may make some useful contributions to improved efficiency. However, outsourcing can expose banks and the banking system to new or increased risks, and it is essential that these risks are managed appropriately. The particular risk that the Reserve Bank seeks to address with the outsourcing policy is the risk that the failure of a service provider to a large bank, or the failure of the bank itself, could lead to disruption of core liquidity, payments and transaction services provided by the bank and the banking system to the wider economy.
Which banks are "large" and what makes them so important?
Under the outsourcing policy, "large" banks are those whose liabilities net of amounts due to related parties exceed $10 billion. Currently, BNZ, ASB, ANZ National, and Westpac are "large". These banks are important because their failure or inability to operate could seriously affect their own customers and also spread damage to the financial system as a whole and the wider economy. Among other things, a failure of such a bank could result in suspension of large volumes of pending payments and settlements, "contagious" financial distress to the bank's creditors - including other banks - and reduced consumer and investor confidence in other banks and the financial system as a whole. It is therefore crucial that a large bank is able to continue to operate even if it may have failed financially, or if one of its service providers has failed or become dysfunctional. The Reserve Bank may look in the future at whether the policy should be extended to other categories of banks whose failure could have an adverse impact on the financial system or wider economy.
Is the policy just aimed at the Australian-owned banks? Why should TSB or Kiwibank be free to outsource wherever they like?
It so happens that all the Large Banks in New Zealand currently are owned by Australian parent banks, but this need not always be the case. The policy would apply equally to a Large Bank owned by interests based in other countries, or owned by New Zealand interests. Also, the formal application of the policy to Large Banks only does not mean that the other banks, including TSB and Kiwibank, are necessarily free to do what they wish with their outsourcing. The Reserve Bank expects all banks, whatever their size or nature, to manage their business risks properly, and this includes risks stemming from outsourcing. This expectation is reinforced by a requirement on directors of any bank to publish a statement every quarter as to whether they believe that their bank had systems in place to monitor and control adequately their bank's material risks, and that those systems were being properly applied.
How has the Reserve Bank factored efficiency into the policy?
The policy takes efficiency into account. In promoting the efficiency of the financial system, the Reserve Bank looks at, among other things, the cost structures of banks. Banks typically seek outsourcing opportunities as a means of lowering their operating costs, and this can promote the efficiency of the financial system. The cost-reducing activities of banks, however, may conflict with financial stability objectives if the risks of disruption to the financial system are increased. In such cases, any efficiency-enhancing activities undertaken by banks must be balanced against soundness objectives. The outsourcing policy has been designed keeping the need for this balance in mind.
The policy is outcome-focused to help minimise any impact on banks' cost structures. Although the Reserve Bank is clear on the outcomes it is seeking from the policy, banks have flexibility to meet those outcomes in the ways that best suit their business. The policy is focused on the goal of ensuring continuity in the provision of core services, and is not prescriptive about the mechanisms by which this outcome should be achieved.
Although there may be costs involved for some banks in complying with the policy, the consequences for the efficiency of the financial system are expected to be quite minor. These costs are expected to be quite small relative to banks' total expenses and profits, and relative to the benefits of improved resilience in the New Zealand financial system. The policy will also be implemented flexibly and on a bank-by-bank basis, allowing each bank to manage compliance costs as part of their normal investment and upgrade cycle. Further, the costs borne by banks are not the only influence on financial system efficiency, with other factors also being important influences on the wider financial system's productive, allocative and dynamic efficiency.
Is this an industrial policy aimed at reducing hollowing out in the banking and IT industries?
No. The outsourcing policy is directed solely to meeting the Reserve Bank's statutory responsibilities under the Reserve Bank Act.
The objective of the policy is to ensure that any outsourcing arrangements for the provision of services to a large bank, whether in New Zealand or cross-border, do not undermine the bank's ability to continue to provide core liquidity, payments and transaction services to the financial system and wider economy.
Is this really an "offshoring" policy rather than an "outsourcing" policy?
No. Outsourcing to any service provider can create risks that must be managed, regardless of the location of the provider. Cross-border outsourcing arrangements may, however, involve additional risks, such as the logistical problems associated with distance, the possible vulnerability to the actions of foreign administrators, courts or regulators, and the need to rely on a foreign legal system for enforcement. Problems of those kinds could, among other things, cause delays in banks' abilities to perform their functions. These additional risks associated with outsourcing to other jurisdictions must be managed satisfactorily to ensure that the required outcome is achieved.
How have the trans-Tasman banking negotiations affected the policy?
The Reserve Bank and New Zealand Treasury have been working with our counterparts in the Australian Treasury, APRA and the Reserve Bank of Australia on legislative changes that will assist APRA and the RBNZ to support each other in the performance of their current regulatory responsibilities at least regulatory cost. Ministers are currently considering the proposed legislative changes. Among other things, these legislative changes would reduce the risks associated with trans-Tasman outsourcing and therefore provide greater scope for large banks in New Zealand to pursue cross-border outsourcing arrangements with parent banks in Australia. The policy has been designed to accommodate flexibly any changes in the legislative environment of this nature.
Does the Bank want to abandon its traditional approach and become a more intrusive regulator?
The Bank remains committed to a serious but comparatively non-intrusive approach to banking supervision. The outsourcing policy emphasises the primary responsibility of a bank's board of directors to determine the best means to meet the policy's required outcomes.
Will you be making the same demands on all large banks under the policy?
Under the policy, all large banks would be required to meet the same outcomes, related to the continuity of liquidity, payments and transaction services. However, banks will have flexibility to tailor their individual arrangements to meet the required outcomes, to accommodate their different starting positions and circumstances, and different business models.
How does your policy compare to those of other bank regulators?
Financial regulators in many jurisdictions, including Australia, Canada, Hong Kong, Singapore, the UK, the US, Japan, and many others have established policies in one form or another on outsourcing. The common themes in these policies, which are echoed in the Reserve Bank's policy, are that a firm which outsources functions must ensure that the arrangements are adequately managed, that the viability of the firm is not compromised, and that the firm keeps its regulator apprised of developments in its outsourcing arrangements.
New Zealand's banking system has the fairly uncommon characteristic that the large banks are all owned by parent banks in a single country (Australia), and have extensive outsourcing arrangements for their business functions with their parent banks. Thus, the Reserve Bank's policy focuses to a somewhat greater degree on ensuring that outsourcing activities do not compromise the continuity of provision of the core liquidity, payments and transactions services of the large banks, which are crucial to the functioning of the financial system and wider economy as a whole.
How much outsourcing has happened already?
Some large banks have already outsourced large parts of their IT and back-office processing functions.
What practical impact do you expect the new policy to have?
The practical impact is likely to vary from bank to bank, depending on their current configurations and how they would propose to meet the policy's requirements. We will be working with banks to develop any paths to compliance that may be necessary for the banks, taking account of their business needs and investment and upgrade cycles.
