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From the Examiner's Desk... Enhancing Examiner Review of Technology Service Providers
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An increasing number of insured institutions are outsourcing software development and maintenance, data processing, and other information technology (IT) services to technology service providers (TSPs); in many cases, these outsourced services are critical to bank and thrift daily operations. Key components of the payments system, including credit card services and automated teller machine (ATM) networks, also are operated and managed by TSPs. Because of the vital role of TSPs in the safe and sound operation of many insured depository institutions, the Federal Financial Institutions Examination Council (FFIEC ) has established a process for examining these companies.
This risk-focused examination process considers all available supervisory information in the development of a TSP's risk profile. However, the results of a project conducted by the FDIC suggest that the identification and evaluation of publicly available information sources would benefit the examination planning process. This article provides an overview of the potential risks TSPs pose to insured institutions, describes the current examination approach to reviewing TSPs' services, and offers a framework for incorporating publicly available information into the examination process.
Assessing the Risk Profile of Third Party TSPs
During the past several years, major TSP firms have grown significantly, relying on acquisitions to expand business and product lines and add new ones, with some firms now serving about 2,000 institutions.1 Aggressive acquisition strategies, while promoting economies of scale, also may pose downside risks for individual TSPs and their clients. For example, a flawed acquisition strategy may weaken the financial condition of the acquirer, or a poorly planned integration could heighten operational or security risk. In addition, the level of concentration risk to bank clients may increase as individual TSPs expand through mergers and acquisitions. Any financial or operational problem these larger firms experience undoubtedly would affect a greater number of clients. Furthermore, the degree of disruption to a single client bank's operations could worsen dramatically, depending on the seriousness of the issues facing the TSP.
Services conducted by TSPs for their bank clients fall within the purview of bank examiners. The Bank Service Company Act grants Federal financial regulators the statutory authority to supervise the activities and records of a bank or thriftregardless of whether the institution or a third party performs the activities.2 Bank supervisors recognize the potential risks posed by TSPs to the banking industry and have developed and implemented appropriate examination policies and procedures.
The National Examination Program
The FFIEC's national examination program (NEP) examines multi-regional data processing servicers (MDPS ) and conducts shared application software reviews (SASR ). A TSP is considered for the MDPS program if it processes critical applications, such as general ledger or loan and deposit systems, for a large number of financial institutions with multiple regulators or geographically dispersed data centers. The SASR program uses interagency resources to review major stand-alone and turnkey software packages that involve critical applications used by a significant number of financial institutions.3 The NEP is based on the concept of ongoing, risk-based supervision. This program identifies those TSPs that warrant examination and develops a supervisory strategy for each company that reflects the level and direction of key risk areas.
As part of the FFIEC's examination program, data about the operations of a TSP are captured on an "Examination Priority Ranking Sheet." The FFIEC uses this information to determine supervisory priorities based on the TSP's business line risks, client base, and the adequacy of internal controls and risk management practices.4 This ranking sheet provides a framework for examiners to use in assessing the following risk categories: number of clients, previous examination's Uniform Rating System for Information Technology (URSIT ) rating, adequacy of oversight of audit reporting provided by client banks, reliability of the technology used by the TSP, and any previously reported problems (see Table 1).5
Based on the information collected on this worksheet as well as from other supervisory activities and third party reports, such as external audits, examiners develop an initial TSP risk profile and assign a risk ranking (Higher, Average, or Lower) for each category. These rankings then translate into an examination priority rating of A, B, or C that determines the frequency and scope of on-site examinations and off-site monitoring; the relationships of the risk rankings to the examination priority ratings are shown in Table 2.
Overall, this approach has served examiners well as they plan and scope examinations of TSPs. However, supplementing these programs with research from publicly available sources may enhance examiners' understanding of TSP risk profiles.
The Value of Information from Public Sources
Insight into the financial condition, reputation, and strategic focus of large, publicly traded companies, including TSPs, can be gleaned from an analysis of publicly available information, such as financial statements and Securities and Exchange Commission (SEC) filings, securities analyst and debt rating agency reports, news reports and press releases, consulting firm reports, and company websites.
Large TSPs often have ancillary business lines, and examiners may want to know whether any problems in these other business lines are weakening the parent company's financial health or diverting management's attention. Evaluating the TSP's contribution to parent company revenues and earnings can provide insight into the TSP's strategic importance.
Supervisory (nonpublic) information, such as risk assessments and auditor findings, reviewed before an examination may provide details about a TSP's risk profile that are not available from public information sources. A review of recent examination findings may help an examiner focus his or her efforts, such as in the case of a TSP that had been criticized for lax security procedures. However, supervisory information alone may not provide a comprehensive picture of the TSP's operations and strategic direction. For example, when examination findings are supplemented with publicly available information about a TSP's recent acquisitions, supervisory concerns may arise about the acquirer's ability to integrate disparate systems and corporate cultures or the potential for management's attention to be diverted from maintaining the highest levels of security.
A review of public information can broaden an examiner's understanding of the financial condition and operational issues facing a TSP, particularly when the TSP is engaged in business lines outside traditional banking services. For example, the examination may conclude that all of the TSP's bank services lines are well managed and financially viable; yet information gleaned from publicly available sources, such as analysis of acquisitions and divestitures, may show that the bank services line is no longer a strategic priority for the firm, suggesting a potential change in company focus, capital investment, or other factors affecting the company's risk profile. Overall, the analysis of public information, along with a review of examination findings, should strengthen examiners' evaluation of the level and direction of operational or concentration risk facing a TSP's clients.
A Framework for Strengthening the Review of TSPs
The benefits of considering supervisory and publicly available information about a TSP's operations were reinforced through the efforts of a team of technology specialists, financial analysts, and economists at the FDIC. Significant publicly available data about nine of the largest TSPs that provide IT services to banks were gathered, analyzed, and supplemented with data gathered through examinations. As a result of this project, additional off-site analytical tools have been identified that will help examiners assess risks specific to these third-party providers. Going forward, the results of this program suggest that monitoring of public sector data and information about major TSPs by analysts and examiners, using the framework developed through this project, will benefit examiners' understanding of the risk profiles of large TSPs.
Table 3 lists public information sources and search tools that can be used to "mine" these sources. Subscription fees may be required, and examiners may find some or all of these sources available through agency-held licenses.
An analysis of these information sources can help examiners assess a TSP's financial condition, corporate profile, and any pertinent regulatory and legal issues more completely and should address the following areas:
Review and analysis of public information sources can provide insight into a TSP's strategic direction. Is it likely to be an acquirer or an acquisition target? Types of acquisitions may indicate potential risks or diversification plans. Is any negative press emerging about a particular technology used by a TSP? Combining supervisory information with carefully mined public information will improve the development and maintenance of accurate and meaningful risk profiles. This approach to evaluating TSPs expands the information and data sources available to on-site IT examiners during the pre-examination planning process and strengthens the supervisory response to potential risks posed by these companies.
Douglas W. Akers
Jay W. Golter
Brian D. Lamm
Kathryn M. Weatherby
2 Bank Service Company Act (12 U.S.C. 1867 ).
3 Federal Financial Institutions Examination Council, Information Technology Examination Handbook , "Supervision of Technology Service Providers," March 2003, pp. 15-22.
5 The FFIEC agencies use URSIT to assess and rate IT-related risks of financial institutions and TSPs. The primary purpose of the rating system is to identify those entities whose condition or performance of information technology functions requires special supervisory attention. See Federal Financial Institutions Examination Council, Information Technology Examination Handbook , "Supervision of Technology Service Providers," March 2003, pp. 5-6.
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