The average community bank or credit union has between 400 and 600 vendor agreements. That’s a lot of contracts to manage. Without a standardized and centralized approach to contract management, there’s no way for a financial institution to truly understand its third-party risk or the controls available to manage it.
Third-party vendor contract management is the process a financial institution uses to analyze, organize, and oversee its third-party vendor contracts and agreements. The goal is to maximize performance and value while mitigating risk.
Contract management falls under the umbrella of third-party risk management (TPRM) and is an essential element of any vendor management program.
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Contracts are the building blocks of any business arrangement – including those between a financial institution and a third party. They define the relationship by outlining key terms and provisions, including costs, key dates, risk controls, remedies, and termination processes, among others.
Vendor outsourcing is one of the biggest expenses at a financial institution. Successful third-party relationships don’t just happen. They are the result of careful planning and oversight. Contracts and vendor agreements give financial institutions the tools to monitor the relationship and protect consumers.
In fact, they are the most effective third-party risk control a financial institution has. It’s where a vendor promises to look out for the interests of a financial institution, meeting obligations and performance standards, and provide documentation that allows an FI to follow up and ensure those promises are being met.
Regulators know this. Understanding contract provisions – and negotiating beneficial terms – is more than a best practice for financial institutions. It’s a regulatory requirement for banks under the Interagency Guidance on Third-Party Relationships: Risk Management. The guidance, published in June 2023, places a heavy emphasis on third-party contracts, mentioning contracts 109 times.
Under the interagency guidance, banks are expected to negotiate contract provisions that facilitate effective risk management and oversight while clearly defining the expectations and obligations of both parties.
This includes contract information relating to 17 areas:
Free Webinar: How to Negotiate Bulletproof Contracts
Contract management doesn’t end with a signed contract. Negotiating a new agreement is just one element of the three phases of the contract management lifecycle. They include:
Onboarding a new agreement involves negotiating a new agreement, understanding its terms and conditions (ex: price increases, terms, notice required to terminate), their impact on your business, and the controls you need to manage risk (ex: business continuity, notice of breach, compliance). This requires a detailed review of the contract.
First, ensure every contract is uploaded to a single, centralized system. Contracts should be accessible, easy to find, and searchable. This keeps an institution organized – no matter how many offices it has – and ensures there is a single source of truth for all contract information.
Be sure the appropriate personnel have approved the agreement and that that approval is documented. In the case of critical or high-risk vendors, it’s likely you’ll need board approval. In other cases, it will be management or other staff.
Before signing an agreement, it’s a good idea to evaluate it against regulatory expectations.
You’ll also want to analyze the contract for key information and document it in your vendor management system.
Related: Q&A: The Future of Artificial Intelligence and Contract Management
For example, identify costs and price increases to make it easy to answer billing questions. Pinpoint expiration, autorenewal, and other important dates and set reminders so you have plenty of time to negotiate a new contract (or find a new vendor) if needed. Identify the types of audit documentation you’re entitled to receive and when so you can verify you receive everything promised – whether it’s a SOC report, proof of business continuity plan testing, documentation regarding its compliance management system, or something else.
This will set the stage for the second phase: managing agreements.
Many people think contract management goes from negotiation to termination and forget about the phase in between: ongoing management.
Vendor contracts are not crockpots – you do not want to set and forget them. Good contract management includes measuring a vendor’s performance against contractual expectations to ensure the vendor is delivering as promised.
Set up periodic reviews to ensure you’re receiving all the documents you were promised. Review vendor incident data to see if the vendor is falling short of performance standards. Documented complaints, mistakes, and other issues can help identify problems with a vendor’s performance before it snowballs into a larger problem and give you the leverage you need to correct the problem or receive compensation.
The risk environment is constantly changing. Periodically reviewing contracts helps ensure that risk controls are keeping pace. For example, enhanced regulatory scrutiny of banking as a service (BaaS) relationships might inspire your institution to try and renegotiate a contract to increase controls and reduce risk in certain areas.
Don’t wait for a vendor dispute to review a vendor contract. Ongoing contract management can prevent a host of problems.
Related: 6 Features to Look for in a Contract Management Software
Contracts end for many reasons. Contracts expire, or an institution might want to move to a different vendor, bring the activity in-house or discontinue it.
When an agreement comes to an end, you want to ensure a smooth transition. Good contract management requires that you understand the implications of terminating an agreement. For example, how much notice of termination must you give? Are you allowed to terminate early if the vendor doesn’t meet service levels? Are there termination fees?
Then there are questions about what happens to your data? Is it destroyed? Returned to you? Are you able to export your data? Is there a cost involved?
What other post-termination obligations must you address?
The good news when terminating a vendor contract is much simpler when an institution has been proactive throughout the contract management process. Deadlines won’t sneak up on you since you will have already identified and documented them and created alerts to remind you of pending expiration shouldn’t sneak up on you. They should have already been identified and documented, with alerts to remind you when expiration is pending. There will be plenty of controls to document issues should you need to break a contract early due to vendor defaults.
The biggest challenge in the termination phase should be selecting and onboarding a new vendor, if needed. Your termination homework should already be done.
Related: How to Break Up with Your Vendor
Poor contract management costs American companies billions of dollars every year. Experts estimate that failing to properly manage contracts and engage in vendor risk management can impact the bottom line by as much as 9% of annual revenue. Another study from research group Aberdeen estimates collective losses of around $153 billion annually.
From cost and performance impacts to compliance risks, poor contract management can hurt a financial institution’s bottom line in many ways.
Any one of these oversights can cost a financial institution. Put several of them together and the cost of poor contract management really starts to add up.
Good contract management has many benefits, including the ability to fully realize contractual discounts and rebates, better manage regulatory compliance, and save on administrative costs.
Effective vendor contract management is more than a regulatory requirement – it's a way to make an institution more operationally efficient. Centralizing and streamlining these processes not only enhances performance and better ensures strategic alignment but also mitigates risks.
Technology plays a vital role in contract management. From vendor onboarding to termination and everything in between, financial institutions need a surefire way to hold third parties accountable for meeting the terms of their contracts and ensuring vendors aren’t a source of undue third-party risk.
Key benefits of centralized vendor contract management include:
Another key innovation in contract management is the integration of artificial intelligence (AI). AI algorithms can process large volumes of contracts much faster than human teams, identifying key clauses and potential risk areas swiftly. This speed translates into cost savings and quicker decision-making. AI tools are also adept at uncovering hidden risks in contracts, such as non-compliance with regulatory standards or unfavorable terms.
By centralizing vendor contract management and harnessing the power of AI, financial institutions can not only reduce operational complexities but also gain a competitive edge through enhanced risk management and regulatory compliance. The future of vendor contract management is clearly intertwined with the advancements in AI, paving the way for more streamlined, efficient, and secure financial operations.
Going forward, centralizing and streamlining vendor contract management will be a strategic necessity for financial institutions – enhancing operational efficiency while playing a crucial role in risk management, regulatory compliance, and the bottom line.
Now is the time for FIs to embrace solutions for more effective contract management.
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