Outsourcing in Banking: Everything You Need to Know
Outsourcing in banking has resulted in numerous changes over the past decade, markedly shifting lending strategies and how risk is evaluated. Technology has brought about many of these changes, though its increased use within banking has been slower than in many other industries.
Like any lender, banks leverage these technologies to find new lending opportunities, provide better service to customers, increase operational efficiency, and maintain regulatory compliance.
Because these challenges aren’t as easy for banks to handle on their own as they once were, even the largest banks have increasingly turned to outsourcing. It’s essential to understand what loan services benefit most from outsourcing, the pros and cons of outsourcing, and how to achieve the best results from outsourcing for banks of all sizes.
Four Factors Driving Outsourcing in the Banking Sector
COVID drove many financial institutions to quickly upgrade their technology, allowing them to serve their customers effectively throughout the pandemic. According to a 2021 survey by PricewaterhouseCoopers (PwC), the areas with the highest potential for outsourcing in banking are credit cards and processing payments, along with processing and servicing consumer loans. Yet 30 percent of those financial institutions planned to switch outsourcing providers within the next five years.
This is likely due to the emergence of financial technology (fintech) companies within the banking industry. According to the survey, both big tech and fintech companies are seen as potential partners for outsourcing in the banking sector.
Big tech companies have helped banks with IT outsourcing since the 1960s. While many banks already have beneficial long-term relationships with the big tech firms, fintech providers are seen as more innovative.
The proportion of banking executives open to outsourcing will grow as banks recognize the benefits. Financial institutions of all sizes are adopting technology from outsourced third-party vendors to improve their competitiveness and reduce operational expenses. Moreover, outsourcing in the banking sector continues to increase as it enables financial institutions to adapt alongside technological innovation.
Four main factors are driving this change—
- Increasing consumer expectations: With the emergence of fintech, the consumer experience has become even more critical for financial institutions as they endeavor to stay competitive by meeting increased customer demand for personalized services.
- Lowering risk: As market conditions and heightened regulatory oversight make the banking sector more hesitant to take risks, financial institutions require greater control over their operations and processes to adhere to regulations and remain operationally efficient.
- Regulatory challenges: Technology has helped banks better keep up with regulatory requirements by providing capabilities to evaluate data in real time that enable the development of more efficient processes.
- Technology: Capabilities to process and analyze data more efficiently have brought technologies like artificial intelligence (AI) and machine learning into the banking sector, allowing financial institutions to more easily glean insights from industry trends, as well as from customer behaviors and preferences.
Financial institutions have found they must update their operational practices to succeed. This requires sufficient investment in technology, which pushes banks and other lenders toward outsourcing.
In the banking sector, automation tools and cloud computing solutions have become necessary for financial institutions to compete effectively. Only by making such technological changes can banks meet the needs of their customers while also controlling risk and maintaining regulatory compliance.
Pros and Cons of Outsourcing in Banking
Although time and cost used to be the prime reason banks outsourced non-core functions, the accelerated pace of technological change has shifted what outsourcing in the banking sector entails.
Fintech companies have proven their worth in providing several important functions within financial institutions to both the institution and its customers. Through providing services from cloud data storage to banking applications for customers, outsourcing by third-party providers can offer banks many significant benefits with only a few possible disadvantages.
Advantages and Risks of Outsourcing in Banking
➕Robust data backup and recovery
➕Digital access control
➕Improved regulatory compliance
Advantages of Outsourcing in Banking
- Cybersecurity: Cloud-based outsourcing partners in the banking sector can provide better cybersecurity, as they can automatically update security patches and features to deal with emerging threats.
- Data recovery: Cloud-based outsourcing partnerships allow banks to guarantee continuity in service delivery due to disasters with robust backups that ensure more uptime.
- Digital access control: Allows banks to mitigate the risk of losing customers and other highly sensitive information due to staff turnover through multiple means of authentication.
- Greater efficiency: Automatic upgrades and patches by cloud-based outsourcing partners mean in-house IT can focus on core processes and initiatives and, in some cases, may no longer require a dedicated IT department.
- Innovation: Much of the outsourcing in the banking sector involves partnering with third parties who provide leading-edge digital tools that allow financial institutions to serve their customers better.
- Lowers costs: Through outsourcing hardware, software, and personnel, financial institutions can allocate more resources to their core operations.
- Regulatory compliance: Reporting tools developed by outsourced partnerships are increasingly incorporated into banking systems to help them maintain compliance.
- Streamlined operations: Operational outsourcing in banking leads to less downtime due to redundancies built into the cloud-based servers used by modern vendors.
Risks of Outsourcing in Banking
- Financial risks: Outsourcing in banking can jeopardize a bank’s financial well-being should a vendor fail to fulfill the performance expectations outlined in legally binding contracts; if the third-party provider fails to live up to its agreements, this can result in financial losses for the institution.
- Operational risks: Should a vendor’s systems fail, this directly affects a financial institution’s operations, preventing its systems from providing services to their customers; for this reason, any third-party vendor with whom a bank’s systems are integrated must be sufficiently established and protected to avoid unplanned downtime.
- Regulatory risks: One of the prime reasons many have refrained from outsourcing in the banking sector is due to loss of control over data; as banks face harsh financial penalties should a data breach occur, the desire to maintain regulatory compliance has kept many banks from embracing outsourcing in banking.
- Reputational risks: Choosing the wrong partner when outsourcing can lead to disaster, as any mistakes a vendor might make directly affect the financial institution’s reputation, whether the damage is done due to bad press, security breaches, or violating regulations, poor judgment regarding vendor selection when outsourcing in banking can lead to a hostile response from consumers, frustrated customers and unexpected financial loss.
When weighing the advantages and risks of outsourcing in banking, institutions generally conclude that outsourcing improves the performance of lenders’ loan portfolios by speeding the origination process, reducing lending risks, and increasing efficiency that results from consolidating functions. Likewise, in-house fintech development can result in inefficiencies due to redundancies and duplicated efforts, often creating information silos. For this reason, many financial institutions have begun exploring different models for banking services.
Banking as a Service
According to a 2021 study by PwC, 20 percent of banks looked to expand banking-as-a-service (BaaS) outsourcing models. BaaS describes a model for financial institutions wherein third-party vendors provide various digital banking products and services. It also allows non-bank businesses to partner with banks to offer certain digital banking services—including loans and payment services—without requiring a banking license.
BaaS works by connecting a bank’s system with an application programming interface (API) and webhooks to create a seamless experience through the non-bank provider’s website or app. In reality, this non-bank provider of banking services acts only as an agent in transactions, so it isn’t required to comply with regulatory requirements.
These days, it just takes a few lines of code for any business to provide banking services, and as the non-bank BaaS provider delivers these services through its brand, it’s commonly referred to as “white-label banking.”
Examples of Outsourcing in the Banking Sector
Control is one of the main reasons many banks have been slow to surrender their in-house operations. Keeping data on-premises was often seen as safer, as management of all processes and servers is controlled by the financial institution. Yet, while outsourcing in banking may seem risky, data storage and other processes are often safer under the control of a competent third-party provider.
Commonly outsourced services in the banking sector include:
- Auto dealer relationships
- Brokerage services
- Credit cards
- Cyber and other security
- Data management
- Disaster recovery
- Identity verification
- Loan processing and servicing
- Mortgage lending
- Overdraft protection
- Software application development
Although bigger banks may be able to manage servers and systems in-house, smaller banks may not have the resources and are often limited by budgetary and personnel restraints. For this reason, outsourcing certain functions to a reputable provider makes sense for smaller institutions. This doesn’t mean, however, that larger institutions can’t benefit from outsourcing in the banking sector as well.
Current Trends in Bank Outsourcing
Outsourcing in the banking sector is now moving towards providing services such as end-to-end loan management to optimize the financial institution’s processes while improving customer service. Outsourcing these days involves mundane tasks like routing workflows to eliminate the need for manual handoffs, real-time updates rather than batch cycling of data, and streamlined access permissions that allow loan management from a single platform.
Innovations in outsourcing also include system configurations that allow banks to manage changes in business processes better to maintain agility when economic conditions or regulations change.
Three key areas in which outsourcing in the banking sector is happening include:
- Account administration, such as maintaining general ledgers, posting payments, and closing out accounts.
- Customer care tools aid banks with welcome calling, providing consumers with products or services, and dealing with customer complaints.
- Customer default management through programmed workflows and procedural queuing tools to deal with bankruptcies, collections, and repossession.
Additionally, many banks outsource collateral management for auto loans and leases, including services like managing titles, balloon functions at the end of a lease’s term, and remarketing of leased or repossessed vehicles.
Loan Servicing Outsourcing Benefits for Banks
Outsourcing loan servicing to specialized companies can help banks and financial institutions manage various aspects of loan lifecycles. Banks can benefit from loan servicing outsourcing in these ways:
Cost Savings: Banks can reduce operational costs by outsourcing loan servicing functions. Using the outsourcing provider’s economies of scale and expertise, banks can save on infrastructure, technology, staffing, and training costs.
Focus on Core Competencies: Banks can focus their internal resources and expertise on core competencies like customer acquisition, risk management, and strategic decision-making by outsourcing non-core loan servicing activities. In this way, overall operational efficiency and effectiveness can be improved.
Scalability and Flexibility: Loan servicing outsourcing provides banks with the flexibility and scalability to handle fluctuations in loan volumes. If demand changes, the outsourcing partner can scale up or down depending on what’s needed. Banks can manage resources more efficiently this way.
Expertise and Specialization: Loan servicing outsourcing companies specialize in loan administration, which means they have a lot of experience managing loan portfolios. Their knowledge of industry best practices, compliance requirements, and regulatory changes is extensive. By leveraging this expertise, banks can ensure accurate loan servicing, minimize risks, and stay compliant.
Technology and Infrastructure: Companies providing loan servicing outsourcing have advanced software systems and technology platforms. Outsourcing lets banks access these tools and technologies without investing heavily in developing or upgrading their own. As a result, banks can leverage modern loan servicing capabilities and remain competitive.
Customer Experience: Bank customers can experience significant benefits from outsourced loan servicing. Outsourcing partners can leverage technologies and processes to enhance customer support, streamline communication, and offer self-service options, resulting in a faster response time.
Loan servicing outsourcing offers several benefits, but banks must carefully select and manage their outsourcing partners. A successful loan servicing outsourcing arrangement requires due diligence in selecting a reputable and reliable service provider, strong oversight, and effective communication.
defi SOLUTIONS is redefining the loan outsourcing business with end-to-end software solutions that enable lenders to automate, streamline, and deliver. Borrowers want a quick turnaround on their loan applications, and lenders want quick decisions that satisfy borrowers and hold up under scrutiny. With defi MANAGED SERVICING, lenders can improve operations and processes related to auto loan servicing, leases, and the disposition of leased vehicles, cutting expenses through automation and outsourcing services. For more information on what to look for when considering outsourcing in banking and how we can help, contact our team today and learn how our cloud-based loan origination products can transform your business.