Academic journal article The Reserve Bank of New Zealand Bulletin

The Reserve Bank's Policy on Outsourcing by Banks

Academic journal article The Reserve Bank of New Zealand Bulletin

The Reserve Bank's Policy on Outsourcing by Banks

Article excerpt

1 Introduction

In today's world of global banking and a highly specialised business environment, it is common practice for banks to enter into domestic and cross-border outsourcing arrangements for an increasing range of business activities. The outsourcing providers involved can take a range of forms, including independent specialist providers (such as IT companies) serving a range of industries, and wholly-owned special-purpose subsidiaries within a banking group that provide services to banking subsidiaries elsewhere in the group. Functions outsourced may include the following (either certain aspects or the whole function):

* development of banking application software, and running of banking software on the provider's computers;

* other IT 'infrastructure' functions such as the maintenance of facilities to house customer data and other bank records;

* 'back-office' functions such as processing and settlement of payment instructions;

* finance and accounting; and

* call centres and other customer services. (2)

In New Zealand, outsourcing by banks has reached further across the range of banking activities than is typically the case in most countries, and there remain some strong commercial incentives for banks to continue to seek outsourcing opportunities both domestically and offshore. This probably reflects the predominance in New Zealand's banking system of banks that are either owned by, or are branches of, offshore parent banks--which is itself a reflection of the openness of the New Zealand banking system to foreign bank participation.

This openness provides benefits to the banking system, but comes with risks. (3) The benefits for the local operations may include cost reduction, access to offshore expertise, and attractive funding terms associated with the global bank's (much) larger balance sheet. The risks include 'contagion' through the very same links to foreign operations, which may act as channels for operational or financial distress at the parent bank to spread to the New Zealand operations.

Risks also stem from the parent bank's offshore domicile itself, on the other side of the jurisdictional boundary from the local operation. (4) The jurisdictional boundary creates risk from foreign financial supervisors' legal obligations being, in general, different to the Reserve Bank's. In some cases, there is foreign legislation explicitly conferring a preference on local depositors. The foreign domicile of the parent bank also means that it is legally and practically more difficult for the local bank, the Reserve Bank or the New Zealand courts to enforce a contract with the parent bank, compared to a contract with a local provider--in part because of the possibility of frustration of the contract or some other intervention by the provider's regulator.

In the case of the four largest banks in New Zealand, (5) these risks are of particular concern because each bank by itself accounts for a large proportion of the banking system. Moreover, the New Zealand economy is highly dependent on foreign funding, and the bulk of this foreign funding is intermediated through the large banks. (6) Finally, the New Zealand operations of global banks are all small relative to those banks' overall operations, so the interests of a parent bank or banking group as a whole may not always be consistent with the interests of the local operations. Local bank staff may thus not always have the ability or incentive to act in ways consistent with the interests of the local operations.

Against that background, a number of the Reserve Bank's policies and activities are directed towards maximising the benefits of an open banking system, while minimising the concomitant risks. The next section sets out this legal and policy context, and the third section explains the outsourcing policy itself.

2 Legal and policy context

Chetwin (2006) provides a recent discussion of the Reserve Bank's supervisory approach in the context of the Reserve Bank's local-incorporation policy. …

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