How do you assess and mitigate operational risk from third-party vendors and outsourcing?

Identifying critical vendors and activities involves recognizing those essential for business goals, performance, and value creation. Understanding the services' nature, scope, and impact on operations, customers, and stakeholders is crucial. Criteria like dependency, exclusivity, contract value, regulations, and strategic alignment help prioritize critical vendors and activities.

Here we begin tart by identifying and categorising vendors based on the criticality of services they provide and the inherent risks they pose before any mitigation. We use quantitative risk modelling techniques like Monte Carlo simulations, scenario analysis, or loss distribution to estimate potential disruptions' frequency and severity. We then pair this with qualitative methods—audits, surveys, and interviews—to assess performance, compliance, and governance. By combining these methods, we will gain a holistic view of the risks associated with each vendor, enabling us to target risk mitigation efforts more effectively where it is most needed.

Evaluate vendor and activity risks using inherent and residual risk levels. Employ risk modeling techniques like scenario analysis, loss distribution analysis, or Monte Carlo simulation for estimating operational losses. Utilize qualitative methods such as surveys, interviews, or audits to assess performance and compliance.

Once risks are assessed, we then implement controls aligned with our risk appetite. We leverage established frameworks like COSO, ISO, or COBIT to develop a layered defense. Preventive controls can include regular audits, access management, and compliance checks, while detective controls monitor vendor performance in real-time. Contingency plans should be specific to each vendor’s risk profile, including incident response protocols, alternative suppliers, and recovery plans. This ensures swift reaction and recovery from vendor failures, minimising business disruption. We regularly update these plans to reflect changes in vendor performance or external conditions.

Mitigate risk with controls and contingency plans based on risk appetite. Controls prevent, detect, or correct failures, while contingency plans respond to disruptions. Frameworks like COSO, ISO, or COBIT help design effective measures for operational risk from vendors.

Monitoring and reviewing the risk and performance of vendors and activities involves using risk indicators and metrics to track changes in risk profiles. Risk indicators signal shifts in risk, while metrics serve as benchmarks for evaluation. Tools like dashboards and scorecards can aid in tracking and communicating these indicators and metrics.

Risk management is a dynamic process. We gather feedback from stakeholders—customers, regulators, auditors—on how vendors are performing against expectations. After that we analyse incidents using root cause analysis to understand failures and identify areas for improvement. We conduct gap analyses to benchmark against industry standards or best practices. We use this feedback to strengthen our risk assessment and mitigation strategies continuously. By establishing a loop of learning and improvement, we will create a resilient, adaptive vendor management system that responds proactively to evolving risks, enhancing overall operational security and performance.

In this age where everyone is an expert on AI / ML (okay, that's a lie, but this concept is getting attentions), I can't help but think how the risk management process can go from a passively-preventing mode into an actively-addressing mode. With all the governance and approval procedures that commonly exist in the current business world, why not go one (or more) step ahead to proactively identify where things could go wrong by applying the IoT and even "digital twin" techniques so that risk management function becomes a lot more insightful and fun!

Enhancing risk management processes involves using feedback and lessons learned from stakeholders to identify improvement opportunities for managing operational risk from third-party vendors and outsourcing. Feedback, gathered from customers, regulators, and partners, provides insights, while lessons learned from incidents and audits help in assessing strengths and weaknesses in risk management practices. Techniques like root cause analysis and best practices benchmarking aid in implementing enhancements.

As a Regional Chief Risk Officer, I prioritize operational resilience by proactively assessing third-party risk. We conduct thorough due diligence, evaluating vendor controls, financials, and cybersecurity posture. We don't outsource critical functions without robust risk mitigation plans. Regular performance reviews and contingency plans ensure any disruptions are minimized. By building strong partnerships with vendors, we foster open communication to address issues early and safeguard our operations.

Key areas of focus: 1. A sound supplier pre-qualification process 2. A clear scope from business i.e. what is/are the business objective(s) and resources available and how can the vendor meet the requirements? 3. Performance Metrics at every stage to measure & monitor supplier performance and achievement of the set business objective. 4. An effective communication process spanning across the above 3 processes. The above at the minimum significantly reduces 3rd party risk and once in place, the business can focus on the external risk e.g environment in which the vendor operates, competitors, regulatory aspects amongst others.