Bank Director’s 2022 Risk Survey, sponsored by Moss Adams, finds most bank executives and board members (65%) report that at least one vendor experienced a data breach or ransomware attack in 2020-21. While most weren’t directly affected by these incidents, 60% of respondents whose vendor experienced an attack took the opportunity to update third-party management policies, processes and/or risk oversight in response.

Cyberattacks on U.S. financial institutions are rarely impactful, according to the Financial Services Information Sharing and Analysis Center’s (FS-ISAC) “Navigating Cyber 2022” report. However, the cyber-focused industry consortium added that “several high-profile third-party incidents have impacted the security and availability of products and services used by many financial firms.” Banks have responded by devoting resources to assessing exposure, patching and mitigating, as well as increasing compliance mandates for third-party operational resilience.

Regulators are taking note of the threat. An interagency rule approved by the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. in November 2021 mandates that banks must notify their primary regulator of a cyber incident within 36 hours; this rule went into effect on April 1, 2022. Service providers must notify affected bank clients “as soon as possible” when they determine that a cyber incident has or will cause a “material service disruption or degradation” for four hours or more. From there, banks must assess whether the incident will have a material impact on the organization and its customers, and whether that will trigger a notification by the bank to its regulator.

In March 2022, the Securities and Exchange Commission proposed new rules around cybersecurity disclosure that would include how companies select and monitor third-party providers. And guidance is still pending from the primary financial regulators around risks related to third-party relationships. That guidance would include an assessment of the vendor’s information security program, including if the vendor has “sufficient experience in identifying, assessing, and mitigating known and emerging threats and vulnerabilities.”

Bank boards and leadership teams will need to be proactive — rather than reactive — as regulators get even more serious about this issue. “Know where you stand and what [vendors are] doing to address any of your concerns, and that starts with having a defined criteria of what you require,” says Cody Harrell, managing director at Strategic Resource Management (SRM), a Memphis, Tennessee-based consulting firm.

Broadly, bank executives and boards need to understand the risks inherent with all of the bank’s vendors, including existing ones, says Harrell. “Who are the most critical vendors to our business? Who are the ones that house sensitive data? Where’s our biggest risk? And not only from a liability standpoint, but from an operational standpoint.” If a vendor falls victim to a cyberattack, will the bank still be able to serve customers? “You need to have a vendor due diligence checklist for each vendor, regardless of whether there’s a problem or not,” he adds. “[Make] sure that everyone that’s within the ecosystem is in compliance with your requirements.”

All vendors also need to comply with regulatory guidelines. The November 2021 notification rule specifies that service providers must comply even if the contract states otherwise. But bank boards are ultimately responsible for ensuring compliance. “If the bank doesn’t have a program of regularly conducting annual vendor diligence and sending renewed questionnaires and identifying gaps, then you’re not conducting ongoing diligence,” says Steve Cosentino, a partner at the law firm Stinson LLP who regularly negotiates agreements between banks and their service providers.

Here are four considerations for bank boards seeking to enhance their third-party oversight.

Understand how vendors will respond to a cyber incident. This should be uncovered during due diligence.

When a breach occurs, “how much you did in the vendor diligence area [will impact] how quickly you’re able to respond to an incident,” says Cosentino. “If you have a quality vendor diligence program [with] extensive diligence and ongoing monitoring, those will all be helpful facts if you’re subject to a potential litigation claim or class action, which has been more and more common.”

In line with the regulatory rule around security notifications, banks need to know when they’ll be notified of an incident, and whether the vendor or the bank will communicate with affected customers. And even if individuals weren’t affected, that doesn’t absolve the vendor from notifying the bank, says Cosentino. “It’s evidence of a flaw in [the vendor’s] systems and security processes that next time could potentially affect the bank, and the bank needs to be apprised of what they’re doing to remedy that.” He adds that these obligations could differ in a security breach, where confidential data may have been accessed, versus a security incident, which may not involve the theft of personal information.

Banks should also know if the service provider will engage an outside cyber forensics firm to investigate a breach, and whether that company is on retainer and can respond quickly. “Taking a day or two out to review different forensic investigators and getting a contract in place and all that, that’s time that’s lost,” says Cosentino. Regulators will ask, “Why did it take so long between the time that the breach occurred and [when] the notices went out?”

The bank should also know what the vendor won’t do. “What are the things that my critical vendor, my third-party provider, is requiring me to take care of, that they’re not?” says Moss Adams Partner Craig Sanders. That could include password resets, network design or educating administrators.

Don’t overlook fourth parties. Vendors have their own vendors, from smaller fintechs that may provide ancillary services to big cloud platforms like Amazon Web Services or Microsoft Corp.’s Azure, and those can pose their own risks. Effective diligence on fourth parties can be difficult, says Cosentino, but banks can take a few steps. Questionnaires sent to third-party vendors should address their own due diligence with subcontractors, and banks should access SOC (System and Organization Controls) reports on those fourth parties. In addition, “Put in your agreement some language that says that the service provider may use subcontractors, [but] they always have to be responsible for [their vendors’] actions and omissions,” he says. “But they can only do so after completion of a third-party risk management vendor diligence review consistent with the FFIEC IT examination handbook and interagency guidance on third-party relationships.”

Don’t silo due diligence. The due diligence exercise shouldn’t be limited to the bank’s technology team.

“The IT group doesn’t always have an understanding of all of the software and systems that process personal information or nonpublic personal information. And that slips through the cracks a lot,” says Cosentino. He recommends a data mapping exercise that includes multiple areas so the bank knows where all of its information is housed. “Conduct that review with your IT group, obviously, but also with the marketing team, your sales team, your operations team, your legal team, because you will find when you do that, there are a number of engagements with third-party service providers where nonpublic personal information is involved, and they’re not picked up in the vendor diligence process,” says Cosentino. Involving multiple teams in the bank will ensure everyone’s on the same page before a breach occurs. “If you do have a data security incident, you have to know where all that information is stored, and how to address, analyze and review [where the] personal information is and what actions you need to take with respect to notifications and remediations and all that,” he says.

While multiple teams within the bank should be included along the way, centralizing vendor management — ensuring an individual has responsibility or using a vendor management platform, or both — can help banks stay on track. “A lot of the financial institutions that we see, various departments control a contract or a decision or a vendor evaluation, and they’re not necessarily speaking to the other departments and having a defined criteria that everyone should comply with,” says Harrell. Vendor diligence requires a lot of documentation, and that needs to be tracked. “Make this a systematic approach.”

Set the tone at the top. In a 2019 letter, the FDIC reminded financial institutions that “boards of directors and senior management are responsible for managing risks related to relationships with technology service providers. Effective contracts are an important risk management tool for overseeing technology service provider risks, including business continuity and incident response.”

Unfortunately, boards often lack the skill sets to understand cybersecurity, says Sanders. “They’ve got to have that knowledge and expertise at the governance level to really understand what should be going on.” He recommends that boards hear from the bank’s chief information security officer at least quarterly and should seek the best technology providers that meet the bank’s strategic needs — not selecting a solution because it’s the cheapest option. The bank may find it gets what it pays for.

“Be honest with yourself about where the risk is and what the involvement from the institution is that should take place at the governance level,” says Sanders. “From the top down, give the support to management and compliance to go out and do what they need to do.”

For more information on vendor risk management, you can view “Avoiding Gaps in Vendor Risk Management” and “Vendor Management: What the Board Needs to Know,” both part of Bank Director’s Online Training Series. For advice on tightening up your bank’s cybersecurity practices amid today’s geopolitical tensions, consider reading “From Russia With ‘Love.’” This issue is also addressed in “Ransomware Attacks Heat Up,” the cover story in the fourth quarter 2021 issue of Bank Director magazine.

Bank Director’s 2022 Risk Survey, sponsored by Moss Adams, surveyed 222 independent directors, chief executive officers, chief risk officers and other senior executives of U.S. banks below $100 billion in assets to gauge their concerns and explore several key risk areas, including credit risk, cybersecurity and emerging issues such as ESG. Bank Services members have exclusive access to the complete results of the survey, which was conducted in January 2022.