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The cost of poorly performing IT and intra-group outsourcing in the FS sector - it could be higher than you think
The recent spate of large regulatory fines handed down to Royal Bank of Scotland, NatWest and Ulster Bank, for serious technology and governance failures, demonstrate how critical the understanding, control and oversight of IT systems have now become within the financial services sector.
The fines- £42m by the Financial Conduct Authority , £14m by the Prudential Regulatory Authority and a further €3.5m (£2.75m) fine by the Central Bank of Ireland respectively, relate to a serious IT malfunction in 2012, which left customers unable to access and use key banking services.
The €3.5m fine levied on RBS owned Ulster Bank is the largest ever imposed by Irish financial regulators, who claimed that the breach had “threatened confidence in the operation of the retail banking sector”. The bank has already paid out €59m in compensation to customers, under a redress scheme overseen by the regulator. Additionally, the fines imposed by the FCA and PRA represent the first time the regulators have taken joint enforcement action.
Clearly, the failure of vital IT systems will not go unnoticed by regulators, and should act as an incentive to businesses operating in the financial sector to actively take steps to pre-empt and allocate the risks of such IT failings, rather than face harsh, and avoidable, penalties later on.
The incident in question dates back to June 2012, where an IT meltdown left around 6.5m customers in the UK, and a further 600,000 customers in Ireland, unable to access or use their bank accounts. Normal service was not resumed at the bank until 28 days later. Naturally customers were left outraged, while senior staff attempted to reassure the media that the bank had identified the glitches and were actively fixing the fault.
Initially, the problem was thought to stem from a decision to outsource IT work to contractors based in India. However, upon scrutiny during the subsequent investigation, it became apparent that the problem was primarily the result of “intra-group outsourcing”, where vital IT services, including critical management and risk assessment systems, had been outsourced to the wider RBS Group (which owned Ulster Bank). Specifically, the failure involved a glitch which occurred when key account processing software was upgraded, causing compatibility problems which resulted in millions of accounts being automatically frozen.
It is not the first time that intra-group outsourcings have been found to cause problems in the FS sector. In the UK, Zurich was fined £2.3m in 2010, for the loss of customer data by their South African entity, to whom they had outsourced services .
Problems with intra-group outsourcings
The consequence of the intra-group outsourcing was that key management personnel at the banks retained little oversight, and did not fully understand the IT systems they had in place, nor did they have an appropriate contingency plan for dealing with the risks of such serious IT meltdowns. In essence, the bank did not adequately understand its own infrastructure and software, which were critical to the daily operation of customer banking transactions. These were highlighted as “systematic weaknesses” during the investigation, while Jim Brown, Ulster Bank’s chief executive, accepted the findings in full and admitted that resilience in the bank’s IT systems must “significantly improve”.
What Can FS Sector IT and Outsourcing Customer and Suppliers Learn From This?
- Lesson #1: There is no defence to an issue just because it is caused by a third party outsourcer. Comments made by the Irish Central Bank should re-enforce the importance of having a thorough understanding of any technologies relied on, and adequately ensuring risk is appropriately allocated. “While the Central Bank recognises IT outsourcing is a feature of modern banking business, it is no defence for regulatory failings”. The regulator also stressed that “Ultimate accountability for compliance remains with firms and they must ensure they maintain oversight of outsourced activities.”
- Lesson #2: Those clauses which deal with losses for failures, and discuss regulator fines, investigations and remedial action are not just “theoretical”. There are numerous practical examples of these issues, and unlike other types of regulator fines (e.g. enforcement by the Information Commissioner’s Office under the Data Protection Act 1998), they are not subject to any cap or limit.
- Lesson #3: The ongoing digitisation of banking services has naturally caused many banks to spend more money on the front-office IT aspects of their businesses, which has made outsourcing an attractive option. However, this incident serves as a warning that suitable IT processes, oversight and safety nets must remain in place. The contract with the supplier remains a good place to capture many of these – but not the only place. The risk decisions, policies and procedures of the regulated business must be properly documented and followed.