Tiers aid vendor management (without tears)

Working with third-party vendors can give a bank a competitive advantage by reducing costs and headcount, and allowing it to test the waters on new products and services without a large capital investment. 

However, in many cases, these relationships are more complex than simple outsourcing, with vendors becoming strategic partners to banks. Richard Anderl, senior manager, Financial Services Advisory at Grant Thornton, LLP, told attendees at the 2014 ABA Real Estate Lending Conference in April that 40% of CEOs believe that they will rely on co-development partners for the majority of their innovations over the next three years.

But recent headlines serve as a reminder that working with third-party vendors in critical functions such as mortgage lending can be treacherous. The regulators insist that banks deploy proper risk identification, ongoing monitoring, and savvy contract negotiations when setting up vendor relationships. Capital One was fined $25 million and forced to issue $140 million in customer refunds due to missteps by their third-party call center, noted Molly Curl, bank regulatory national advisory partner, Grant Thornton.

“Financial institutions need to look beyond disaster recovery when it comes to managing vendor relationships,” said Curl.

Real world vendor management

First Federal Bank of the Midwest, a $2.2 billion asset bank headquartered in Bowling Green, Ohio, relies on vendors for many phases of the mortgage life cycle, explained Martha Woelke, senior vice-president and retail lending product manager. The bank created a centralized vendor management function to ensure a strong third-party risk management program.

The bank’s first step was to account for the myriad of current vendor contracts, a process that unfolded over many months because many of the contracts were “owned” by individual business units. Woelke described the process to centralize contract management as difficult, and suggested that banks consider penalizing those areas that don’t comply with the centralization mandate.

Though time consuming, the contract discovery and centralization processes are worthwhile.

“If vendor management is not done properly,” warned Woelke, “time, money, and reputation are at risk.”

The bank then categorized vendors by risk tiers. Vendors that supply products or services critical to the bank’s operations and revenues are Tier 1. By contrast, a Tier 4 vendor is one that is not critical to the bank and that doesn’t require a standard contract.

Applying the process to vendor selection

First Federal Bank relied heavily on its formalized vendor management process when replacing its 15-year-old loan origination system, a Tier 1 risk. Because of the system’s priority, the bank involved the board in the decision making process. Woelke assembled a diverse cross-functional team that included representatives from Origination, Processing, Underwriting, Closing, Servicing, Risk Management, Compliance, and IT to help whittle down the list of potential vendor replacements.

Each representative group supplied a list of “must haves” for a new loan origination system. Woelke and her team facilitated group consensus that was turned into a weighted scorecard to evaluate vendors.

Scorecard creation took three months, noted Woelke, and encouraged bankers to allow plenty time for this step.

Armed with the scorecard and buy-in from the functional areas, the bank requested vendor demonstrations. All demos were done remotely using Cisco WebEx. Video conferencing was advantageous, explained Woelke, because it allowed the bank to remain objective and not swayed by the personalities of individual salespeople

The bank narrowed the list of potential vendors to three that they subjected to extensive due diligence, including financial review and customer reference calls. To ensure consistency, the bank asked each referral the same questions. The bank selected the top two contenders, and after a final round of reference calls, made their decision.

Ongoing process essential

Once a vendor is selected, the business is typically anxious to sign the contract and get started, but Grant Thornton’s Curl urged caution: “Take your time during the contract negotiation.”

First Federal Bank spent two and one half weeks in contract negotiation, including carefully reviewing the termination clause.

Although the bank is confident with its vendor selection, Woelke noted that the actual system conversion was lengthy. “It takes six to nine months to convert a loan origination system—no matter what the vendor says,” warned Woelke. She recommended that banks use a less-risky phased rollout approach for a critical system rather than “flipping the switch.”

Once the conversion is complete, banks need ongoing vendor monitoring. Reporting is critical, and vendors should provide reporting that is “as real-time as possible,” stated Anderl.

What are customers telling you (or the vendor)?

Because regulators are increasingly concerned about customer impact of bank’s third-party relationships, banks need to monitor their customer complaints carefully.

Ideally the bank has access to customer complaints made directly to the vendor. However, Curl noted that vendors are typically tightlipped with that information.

With an increased reliance on third-party vendors and heightened regulatory focus, banks require a vendor management framework that addresses all areas of the vendor lifecycle, including vendor selection, the ongoing transfer of goods and services, and monitoring key risks.