TPRM 101: What is a Vendor Risk Assessment

What are the potential risks of working with a third-party vendor? What can be done to limit those risks? Is it enough to feel confident in the vendor relationship? 

These are questions that can be answered with a vendor risk assessment. Vendor risk assessments help your financial institution proactively identify potential risks, implement effective controls, and address vendor issues before they escalate. This process helps protect your institution from potential threats, such as data breaches, regulatory violations, and operational disruptions, while fostering stronger vendor oversight and accountability. 

Understanding what vendor risk assessments are, why regulators emphasize them, and how to conduct them effectively can provide your financial institution with the tools to address vendor risks confidently. Read on to learn how. 

Related: Essential Risk Assessments for Financial Institutions 

What Are Vendor Risk Assessments? 

Vendor risk assessments are a formal process used to identify, evaluate, and address risks associated with third-party vendors. Think of it as a deep dive into understanding how a vendor’s operations, security, compliance, and overall reliability could impact your financial institution. 

The goal of a vendor risk assessment is simple: ensure that your vendor is capable of delivering its services in a way that aligns with your institution’s expectations while mitigating potential risks. This involves reviewing factors such as the vendor’s financial health, operational stability, and security measures while assessing its ability to meet regulatory requirements and protect sensitive information. 

Vendor risk assessments are part of the due diligence phase of the vendor risk management lifecycle. After collecting due diligence documentation such as SOC reports, financial statements, and relevant policies and procedures, the vendor risk assessment is the tool used to analyze this information to identify any gaps or concerns.  

An effective vendor risk assessment allows your institution to make informed decisions about vendor relationships and identify necessary controls to protect your institution.  

Vendor risk assessments aren’t one-time activities. They take place during onboarding and then throughout the vendor relationship, especially when there are changes to the vendor’s operations, services, or risk profile – or if there are changes in the overall risk environment.  

Related: TPRM 101: What is Ongoing Vendor Monitoring for Financial Institutions?

Regulatory Requirements and Vendor Risk Assessments 

The Interagency Guidance on Third-Party Relationships: Risk Management emphasizes the importance of vendor risk assessments as part of a comprehensive third-party risk management program.  

Regulators expect financial institutions to conduct a thorough evaluation of vendors before entering into a relationship and throughout the relationship. This includes assessing the vendor's compliance with applicable laws, financial stability, cybersecurity controls, and overall operational capacity.  

The guidance encourages institutions to adopt a risk-based approach to vendor risk assessments. Vendors with higher inherent risks, such as those handling sensitive customer data or critical to operations, require more scrutiny than lower-risk vendors. 

Vendor risk assessments must also be documented and reported on, including due diligence results and recommendations.  

While the interagency guidance sets requirements for banks, it’s also a good framework for credit unions and other financial companies since it represents best practices. 

Related: Third-Party Vendors & Compliance Risk: 10 High-Risk Compliance Situations

How to Perform Vendor Risk Assessments 

Effective vendor risk assessments need a structured, comprehensive process.  

Here’s a guide on how to perform vendor risk assessments: 

• Use a risk-based strategy.  Vendors that pose the greatest risk require more scrutiny. It’s not just a best practice – it's something examiners look for. Base the vendor risk assessment on the vendor’s overall risk level. This determines the scope of the vendor risk assessment. 
  
  
• Assess the vendor’s inherent risk. Evaluate the potential risks a vendor poses to your institution before any mitigating controls are applied. (For example, how much cybersecurity risk would there be without protective measures like firewalls). Analyze factors such as the vendor’s access to sensitive data, the criticality of their services to your operations, and potential risks like cybersecurity, financial instability, or regulatory non-compliance. Understanding the inherent risk helps prioritize resources and determine the level of scrutiny needed for the vendor.
  
  
• Classify the vendor’s risk tier – Based on results of the vendor risk assessment process, assign an overall risk tier for the vendor. Consider the vendor’s inherent risks, what the mitigating controls are, and how the vendor may impact your financial institution. Some institutions may use low, medium, and high risk, while others may include tiers like medium-low and medium-high or use a scale from one to five. 
  
  
• Collect due diligence documentation. Ask the vendor to complete a vendor risk questionnaire tailored to its risk profile and the product or service it provides. Gather supporting documentation that demonstrates the vendor’s controls, such as SOC reports and financial statements. Due diligence documents help evaluate how effectively the vendor mitigates risks and identifies any additional controls your institution may need to implement.
  
  
• Review the due diligence documents. Review the questionnaire and due diligence documents and form an opinion on the vendor’s controls. This can be done by the vendor owner, someone in IT, a vendor manager or someone else at the institution – but that person must have the knowledge and skills to interpret the documents and reach an educated conclusion. The reviewer can identify potential issues with the vendor’s documentation, provide an overall risk rating, and document it in a report.
  
  
• Leverage your issue management process to address identified issues. If the issue is discovered pre-contract, require the vendor to resolve it before signing or outline the remediation plan in the contract. For issues arising post-contract, collaborate with the vendor to establish an agreed-upon remediation plan. Ensure the issue, the remediation steps, and the resolution timeline are thoroughly documented.

Vendor risk assessments aren’t just a regulatory requirement – they are a strategic necessity for financial institutions. By following the vendor risk assessment process, your institution can assess and identify vendor risks, resolve issues before they become bigger problems, and stay compliant with regulations.  

Download our free vendor management buyer’s guide.