In the financial services industry, outsourcing has been in use for quite some time. For example, since the 1970s, financial institutions have used outside firms for such clerical activities as printing customer financial statements and storing records. As information technologies (IT) evolved during the 1980s and 1990s, financial services firms began to outsource a great variety of IT activities as a means of lowering their costs and gaining faster access to up-to-date technology. For example, purchasing software for producing internal reports and customer statements from a specialized vendor often provides significant cost savings and greater flexibility over developing and maintaining that software in-house. Current forecasts suggest that this trend toward outsourcing is likely to continue into the near future.
Although outsourcing presents all firms with important challenges, financial services firms face two special issues. One issue involves concerns about maintaining the privacy of customers' financial information; the other involves concerns associated with the relatively high degree of government regulation that these firms face. The latter issue has led to important developments in the government supervision of financial services firms, particularly depository institutions (that is, banks, thrifts, and credit unions).
This Economic Letter reviews both the supervisory concerns and the practices that have arisen in response to the expansion of outsourcing by financial services firms. Government supervisors have adopted general guidelines regarding how the inherent risks should be identified and mitigated. For the U.S. banking industry in particular, supervisors have established explicit procedures for monitoring the outsourcing activities of depository institutions to technology service providers.
Why outsourcing?
Firms may choose to outsource certain activities for various reasons. For example, an outside vendor might provide operational...