RBI issues directions to regulate outsourcing of key functions by NBFCs

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Mumbai: The Reserve Bank of India (RBI) on Thursday prohibited non-banking financial companies (NBFCs) from outsourcing key functions such as internal audit, investment portfolio management, loan sanction, and know-your-customer compliance.

“The failure of a service provider in providing a specified service, a breach in security/confidentiality, or non-compliance with legal and regulatory requirements by the service provider can lead to financial losses or loss of reputation for the NBFC and could also lead to systemic risks,” the central bank notification said, adding that NBFCs outsourcing their activities should ensure sound and responsive risk-management practices.

The regulator listed 10 types of risks arising out of outsourcing that the NBFCs need to mitigate. “Some key risks in outsourcing are strategic risk, reputation risk, compliance risk, operational risk, legal risk, exit strategy risk, counter-party risk, country risk, contractual risk, access risk, concentration and systemic risk,” RBI said.

RBI also said that the service providers need to maintain the same high standards of care in performing the services as is expected to be employed by NBFCs. The notification stated that NBFCs need to ensure that service providers do not impede or interfere with the ability of NBFCs to effectively oversee and manage their activities or impede the RBI in carrying out its supervisory functions and objectives. The boards of NBFCs are expected to lay down administrative frameworks for outsourcing.

RBI has also asked NBFCs to put in place a business continuity plan in case of unexpected termination of an outsourcing agreement.

“In establishing a viable contingency plan, NBFCs shall consider the availability of alternative service providers or the possibility of bringing the outsourced activity back in-house in an emergency and the costs, time and resources that would be involved,” the notification stated, adding that NBFCs shall retain an appropriate level of control over their outsourcing and the right to intervene with appropriate measures so that business is not interrupted.

NBFCs will also be required to conduct audit of the service providers at least once a year to assess their financial and operational condition. The lenders are expected to comply with the directions within two months.