Vendor diversification: more important than ever

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The introduction of COVID-19 into our economy has forced mortgage companies to take a hard look at efficiencies and determine how to ensure uninterrupted, high-quality service delivery.

As the recent pandemic has shown, a company's own service delivery can be at risk if its only provider has a downgrade in its service level, lacks an adequate disaster recovery plan or is not agile enough to manage unforeseen events. Now is a good time for financial institutions, including banks along with mortgage lenders and servicers, to review their vendor selection strategies to help hedge against a further risk of supply chain disruption.

It is not uncommon in manufacturing for companies to look at their procurement strategies and decide if they want to go with multiple vendors or just a single source. This approach is often used in the service sector as well. A section in the Dodd-Frank legislation called for regulatory agencies to exam the vendor management practices of financial institutions, including how they provided oversight of their third-party service providers.

Those reviews found critical weaknesses in overseeing and monitoring these vendors. While one result was financial institutions using multiple vendors in the default area, they have not necessarily considered this strategy for other services and products, such as tax tracking and flood determination services. But they should.

Regulators, including the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Consumer Financial Protection Bureau, have made it clear that an institution's board of directors and senior management are ultimately responsible for managing activities conducted through third-party relationships and identifying and controlling the risks arising from such interactions.

It is management's responsibility to ensure that the activity is performed in a safe and sound manner and in compliance with applicable laws. Failure to manage risks — operational, reputational, transactional and compliance — can expose an institution to regulatory action, financial loss, litigation and reputation damage and may even impair the institution's ability to establish new relationships or service existing customers.

To control these risks, the regulators suggest that in their risk management plan, financial institutions should include initial due diligence as well as a periodic review and assessment of their service providers' business resumption and contingency plans. The guidance also seeks to ensure that there is adequate oversight to determine that risks and quality of service are being controlled.

Despite the various risks, many companies still focus on the advantages of a single vendor model in some areas of their business. They are stuck on building and maintaining a relationship with one vendor because it may be easier and/or simpler to streamline and integrate systems.

There may also be the ability to maximize volume to leverage attractive pricing with one vendor; however, placing all your eggs in one basket and being dependent on a single source and vendor can carry large risks to your business and customers.

A smooth flow of services that is disrupted due to capacity constraints, financial complications, mergers and acquisitions, quality issues or national disaster can have a profound effect on a company. Having two or more vendors will increase a company's ability to circumvent disruptions, including severe weather or other service interruptions. There also is the risk with a single vendor that over time the balance of the parties' relationship will become lopsided, which could result in reduced service standards.

A multivendor model presents opportunities to take advantage of competitiveness between vendors. This could translate into better service levels and management of volume fluctuations if you have a choice of vendors with whom to adjust order activities. This model also gives financial institutions greater access to diversified pools of industry experience, innovation and new technology and products. In short, with multiple vendors you can reduce your dependency on one vendor and balance your risk.

Having multiple vendors can help redistribute risk, thus reducing the overall peril to the organization. This allows the financial institution to ensure that they can transition activities to another third party without any downtime or effect on their customers in response to a contract default or termination or with service interruptions or degradations.

It is important to be proactive; now may be the time to assess your vendor procurement strategy and decide whether having alternative vendors for your tax tracking and flood determination services makes good sense for your organization.

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Outsourcing Underwriting Nonbank Natural disasters Compliance Risk management Mortgage defaults Dodd-Frank