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The Reserve Bank of India on Monday directed cooperative banks not to outsource core management functions such as policy formulation, internal audit and compliance, compliance with KYC norms, credit sanction and management of investment portfolio.

Issuing guidelines for managing risk in outsourcing of financial services by cooperative banks, the central bank said the lenders can hire experts, including former employees, on a contractual basis subject to certain conditions.

Outsourcing' is defined as use of a third-party to perform activities on a continuing basis that would normally be undertaken by a cooperative bank itself, now or in the future. 'Continuing basis' would include agreements for a limited period.

Cooperative banks are increasingly using outsourcing as a means for reducing costs as well as for availing specialist expertise, where these are not available internally.

While it is entirely the banks' prerogative to take a view on the desirability of outsourcing a permissible activity having regard to all relevant factors, including the commercial aspects of the decision, such outsourcing results in banks being exposed to various risks, the RBI said.

"Cooperative banks which choose to outsource financial services, however, shall not outsource core management functions including policy formulation, internal audit and compliance, compliance with KYC norms, credit sanction and management of investment portfolio," the guidelines said.

The guidelines, the RBI said, have been issued to enable the cooperative banks to put in place necessary safeguards for addressing the risks inherent in outsourcing of activities.

They have been asked to conduct a self-assessment of their existing outsourcing arrangements and bring the same in line with these guidelines within a period of six months.

As per the guidelines, outsourcing of any activity by a co-operative bank does not diminish its obligations and those of its Board and CEO along with the management, who have the ultimate responsibility for the outsourced activity.

A cooperative bank intending to outsource any of its financial activities will have to put in place a comprehensive outsourcing policy, approved by its Board, in line with the criteria indicated in the guidelines.

The indicative key risks in outsourcing that need to be evaluated by the co-operative banks, include, strategic risk, reputation risk, compliance risk, operational risk, legal risk, exit strategy risk, and country risk.

Also, the terms and conditions governing the contract between a cooperative bank and service provider should be carefully defined in written agreements and vetted by bank's legal counsel on their legal effect and enforceability, the guidelines said.

Further, in order to mitigate the risk of unexpected termination of the outsourcing agreement or liquidation of the service provider, cooperative banks shall retain an appropriate level of control over their outsourcing and the right to intervene with appropriate measures, to continue their business operations in such.

If a service provider's contract is terminated prematurely prior to the completion of the contracted period of service, Indian Banks' Association (IBA) would have to be informed with reasons for termination. IBA would be maintaining a caution list of such service providers for the entire banking industry for sharing among banks.

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Free Press Journal