2 November 2004
RBNZ releases draft outsourcing rules for banks
The Reserve Bank today published its proposed policy on outsourcing by large New Zealand banks. The Reserve Bank is seeking feedback from registered banks and other interested parties before finalising the policy in early-2005.
Reserve Bank Deputy Governor Adrian Orr commented "The Bank is not against outsourcing per se, and sees it as part of the fabric of the global financial system. However, outsourcing can expose banks, and hence New Zealand's financial system as a whole, to risks that must be managed.
"The proposed policy would require a large bank's board of directors to have the legal and practical ability to operate their bank stand-alone, if the bank's owner, or another provider of services to the bank, failed. This would also need to apply should a statutory manager of the bank ever be appointed.
"The proposed policy would also require the board of each large New Zealand bank to exercise meaningful control over the terms of employment of the bank's chief executive, and would require the bank's staff to report ultimately to that chief executive.
"The proposed policy would not permit systemically important banks to outsource key functions where, as a result, their ability to keep operating in a crisis could be put at risk. Thus, for example, if a large New Zealand bank wanted its owner or another party to process its transactions, this would not be permitted if it meant that the New Zealand bank couldn't function if the owner or other party failed.
"We have tried to ensure that efficiency is not unduly impeded in our proposed policy by focusing on the outcomes we require, rather than being prescriptive. This provides banks with flexibility to meet our requirements in a way that suits their individual circumstances and business models."
"These proposals continue the development of the Reserve Bank's bank failure management framework, which has been underway for some time. They also reflect the 2003 amendment to the Reserve Bank of New Zealand Act which explicitly made outsourcing a relevant issue for the registration and supervision of banks.
A fact sheet is attached and the proposed policy, with a letter to all banks providing context is available.
For further information contact
Paul Jackman
Head of Corporate Affairs
Ph 04 471 3671, 021 497 418, Jackmanp@rbnz.govt.nz
Outsourcing policy proposals: FAQs
What is outsourcing?
Outsourcing can be defined as the use of another party (either a related party or an independent party) by an entity to perform activities that would normally be undertaken by the entity. Outsourcing by banks has increased rapidly in the past decade as communications and information technology has evolved and improved. Common examples of outsourced activities include IT processing, accounting, and call centres.
Is the Bank against outsourcing?
The Bank is not against outsourcing per se, and sees it as part of the fabric of the global financial system. However, outsourcing can expose banks to particular kinds of risks, and to the extent that these risks are not managed adequately, they may be matters of regulatory concern. These risks stem from outsourced functions being less subject to the bank's management control and board governance, the vulnerability of the bank to the failure of service providers, and possible impediments to a statutory manager being able to maintain operations in a crisis situation. The latter would be critically important where the bank is systemically important.
What is so important about systemically important banks?
A systemically important bank is one whose size and nature of business is such that their failure and inability to operate could spread and cause damage to the financial system as a whole. This damage comes from, for example, the liquidity implications to the economy as a result of a bank being unable to meet its payment and settlement obligations, propagation of the financial distress to the bank creditors - particularly other banks, and the implications for consumer and investor confidence in other banks and the financial system as a whole.
Thus, to reduce the systemic and economic implications of a bank failure, it is crucial that a systemically important bank is able to continue to operate even though it may have failed financially.
The Reserve Bank's definition of a systemically important bank is one whose liabilities net of amounts due to related parties exceed $10 billion. The current systemically important banks in New Zealand are BNZ, ASB, ANZ National, and Westpac.
What is the Bank's proposed outsourcing policy?
Our proposed outsourcing policy would require that any outsourcing done by systemically important banks does not undermine the bank's ability to be operated on a stand-alone basis. This objective ties directly to the Reserve Bank's responsibility to supervise registered banks for the purposes of promoting the maintenance of a sound and efficient financial system or avoiding significant damage to the financial system that could result from the failure of a registered bank.
The policy would require there to be legal and practical certainty that, in the event that a bank's service provider, the bank itself, or its parent, failed, a statutory manager would be able to operate the bank, including having certain access to any functionality necessary for this purpose.
How has the Bank factored efficiency into its analysis?
The Bank has formulated this proposed policy with both soundness and efficiency in mind. The aim is to ensure that at least the core processes and people needed to keep the bank running are available to the board or statutory manager during times of financial stress. We believe that the financial system resilience that comes from an effective outsourcing policy can be achieved with little if any reduction in operational efficiency. We have tried to ensure that efficiency is not unduly impeded in our proposed policy by focusing on the outcomes we require, rather than being prescriptive about the mechanisms by which the outcome should be achieved. This provides banks with flexibility to meet our requirements in a way that suits their individual circumstances and business models.
Is this an industrial policy aimed at reducing hollowing out?
No. The Bank's outsourcing requirements are directed to solely to meeting our statutory responsibilities under the Reserve Bank Act.
The objective is not to retain IT services or other industries in New Zealand, but rather to ensure that any IT or other services provided to banks under outsourcing arrangements, whether in New Zealand or abroad, include the protections that would be required to avoid significant damage to the New Zealand financial system that could result from either the failure of a registered bank, or of a material provider of outsourced services.
Is this really an "offshoring" policy rather than an "outsourcing" policy?
No. Outsourcing to any service provider can create risks of concern that must be managed, regardless of whether the provider is located in New Zealand or offshore. It is true, though, that an offshore outsourcing arrangement might create additional risks, such as having to rely on a foreign legal system for enforcement, logistical problems associated with distance, and possibly vulnerability to the actions of foreign regulators.
Does the Bank want to abandon its "light-handed" approach and become a more intrusive regulator?
The Bank remains committed in general to a light-handed, non-intrusive approach to banking supervision. Consistent with that approach, the proposed approach to ensuring compliance with the policy would emphasise the responsibilities of boards determining the best means to meet our requirements. Any required investment for crisis management under our stand-alone capability objective would be, in our view, worthwhile over the long haul for the costs of crisis it would avoid - even it if means having to be intrusive with banks on this particular issue.
Will you be making the same demands on the other banks as you have with ANZ National?
Any policy is necessarily general in expression and specific in application. Under the proposed policy, all systemically important banks would be required to meet the same outcome - that their outsourcing activities must not compromise their stand-alone capability. However, they each start from different positions and circumstances, and have different business models. Application of the proposed policy would account for these differences in its application and allow flexibility for individual banks to meet our required outcomes.
We have begun a process of engaging with both ANZ National (due to their amalgamation) and with Westpac (due to their mainframe processing plans) on how their arrangements stack up in terms of stand-alone capability already, which is work in progress.
How does your proposed 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 all promulgated policy in one form or another on outsourcing by institutions in their patch. There are common themes in all of these pronouncements that we have picked up on in the proposed policy, such as that outsourcing must be adequately managed and must not compromise the viability of the institution, and that the institutions must keep their regulators apprised of what is going on with their outsourcing arrangements. However, New Zealand's banking system has the very uncommon characteristic that all our systemically important banks are owned by offshore parent banks, and have a high degree of integration of business functions with their parent banks' functions. Thus one area of greater focus in our proposed policy, compared to those of other regulators, is on the implications of this form of outsourcing for the stand-alone capability of banks in New Zealand under crisis circumstances.
