- Key insight: Federal regulators are recognizing the unique role core servicers play for community banks and proposing stricter oversight of these relationships.
- Expert quote: "It is important that the board continue to foster responsible innovation and facilitate banks' pursuit of third-party arrangements in a manner consistent with safe and sound practices and in compliance with applicable law, including those designed to protect consumers. A principles-based and risk-focused approach may be helpful towards promoting these goals — especially for enabling innovation and competition for vendor services." — Federal Reserve Gov. Lisa Cook
- Forward Look: The public has 60 days to comment on the proposed guidelines.
Federal regulators are looking to scrutinize core servicers relationships more carefully to encourage transparency.
The Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and National Credit Union Administration proposed new guidelines for third-party relationship supervision on Friday morning.
In particular, the guidance is aimed at improving the dynamics between community banks and the core service providers. The proposal would empower regulators to apply more supervisory oversight to transparency, contract structures and technology components within these relationships.
"The proposed guidance reflects the agencies' supervisory experience and lessons learned from examining financial institutions' third-party risk management practices," the agencies said in a joint statement. "It is intended to assist banks and credit unions to better align and tailor their third-party risk management practices to the risks of individual third-party relationships."
The agencies also note that the guidance uses a "principles-based approach" and is not binding.
Core service providers handle many of the most important and technically complex back-end functions of client banks, which are typically small- to medium-sized community banks and credit unions. These include account management, transaction processing and loan servicing. The agencies noted that many small banks and credit unions have relied on these firms to remain competitive in a fast-evolving market.
The agencies also highlighted the fact that the core services sector is highly concentrated, giving banks few options to choose from. The proposal seeks to address some of the competitive challenges that come with such constrained market dynamics through risk-based examinations of these arrangements.
The proposal calls for agencies to provide additional supervisory scrutiny to core services arrangements that provide limited transparency to community banks as well as those that "unreasonably limit [banks'] ability to conduct due diligence and ongoing monitoring or to negotiate contract terms that address their business needs."
The proposal also highlights the unique role core servicers play in providing technology to community banks. Because of this, it calls for closer oversight of servicers' technology investments and capabilities.
Along with these proposals about core servicing relationships broadly, the agencies also issued a joint proposal pertaining specifically to so-called "traditional" community banks and their third-party service providers. This proposal calls for less supervisory oversight of banks that do not engage in novel activities, such as fintech partnerships and digital asset services.
In a statement issued alongside the proposal, Fed Gov. Michael Barr took issue with the fact that the guidelines for the traditional community bank proposal were more specific than the broader third-party guidelines. Community banks that do engage in fintech partnerships and digital asset services likely would benefit from additional and more precise guidance on how to manage their third-party relationships.
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"Experience suggests that many banks with complex business models are especially in need of guidance that better addresses their particular third-party risk management issues, which is not addressed in these proposals," he said.
Barr also expressed concern that the proposals call for giving "due consideration to a banking organization's reasonable decisions," could be interpreted as the agencies giving deference to individual banks to set their own best-practice standards.
He also flagged the fact that neither proposal makes mention of consumer compliance standards, a fact that could inadvertently remove the oversight of such issues from the agencies' guidelines should the proposal be adopted as is.
"A final rule could end up rescinding existing guidance, leaving a big gap in risk, or banks could end up needing to comply with two sets of guidance, sowing confusion and increasing burden," he said.
Barr was the lone dissent to the proposal from the Fed Board of Governors, which voted 6-1 to issue the proposed guidance.
Fed Gov. Lisa Cook issued a statement supporting the proposals as a needed step to facilitate responsible innovation within the community banking sector.
"It is important that the Board continue to foster responsible innovation and facilitate banks' pursuit of third-party arrangements in a manner consistent with safe and sound practices and in compliance with applicable law, including those designed to protect consumers," Cook said. "A principles-based and risk-focused approach may be helpful towards promoting these goals — especially for enabling innovation and competition for vendor services."
The proposals will be open to public comment for 60 days following publication in the Federal Register.
