Background

The use of offshore contractors has grown dramatically in the past few years due to the flexibility offered by new information technology and the prospect of lower costs. At the same time, consumers have become more concerned about privacy and the potential for abuse of personal data as instances of fraud, such as identity theft, have become commonplace. In light of these developments, the purpose of this study is to gauge the risk to personal privacy posed by the offshoring of those financial institution functions that require customer data, focusing on:

During the course of this study, FDIC staff reviewed existing publications and articles; and also met with other regulators and industry representatives, consulting firms and research organizations that are monitoring this topic. Despite the scope of this inquiry and research, little data was available on the precise amount of work presently being offshored by financial institutions. As such, this study endeavors to frame pertinent issues and identify areas warranting increased focus and data collection.

Trends in Offshoring
Financial institutions have outsourced functions to domestic third-party service providers or domestic affiliates for many years. In recent years, the growth of low-cost, well-educated labor pools and the development of low-cost data transmission capabilities have led to a significant amount of work going to offshore concerns. Businesses are now able to take advantage of huge, low-cost labor pools such as the well-educated work force in India. A host of other countries are also commonly used for offshoring. These locations are listed in Appendix A.

Estimates concerning the extent of offshoring and its prospective growth are difficult to reconcile. A recent study by Deloitte Consulting projects that 15 percent of the U.S. financial services industry cost base will move offshore within the next five years.³ Another survey conducted by the Tower Group, focusing on different statistics, indicates more moderate growth will occur. According to the Tower Group, growth should not exceed 15 percent of financial institution outsourcing in the next eight to ten years.⁴

In spite of different estimates of growth levels, most believe that offshoring will continue to increase for the foreseeable future. As shown in Chart 1, the Tower Group estimates that the share of offshored global financial services IT spending has steadily increased, from 50 percent in 1996 to 56 percent in 2003. While difficult to project with certainty, there are strong indications that offshoring will continue to grow into the future.

Chart 1

d

Reasons for Offshoring
The increasing instances of offshoring by many U.S. financial institutions and their data vendors are due in large part to the potential cost savings that are achievable as low-wage labor pools are tapped in foreign countries. The Gartner Group estimates that offshore software development cost savings can be as much as 75 percent when compared to the cost of similarly skilled local labor and technical resources with those available overseas.⁵ Deloitte Consulting, LLP, estimates that financial institutions that offshore functions achieve an average cost savings of 39 percent, with one in four institutions surveyed achieving savings of more than 50 percent through offshoring.⁶ One data vendor reports cost savings of greater than 50 percent in their offshored program development work.

As shown in Chart 2, the Tower Group estimates large potential cost savings are available for offshore outsourcing of both Information Technology Operations (ITO) as well as Business Process Operations (BPO). Although potential cost savings of 35 to 60 percent are said to exist, the net savings falls to somewhere within half of that range after deducting associated costs, chief among which is IT governance.

Chart 2

d

Another reason for the growth in offshoring is that companies have found it desirable to be able to continue their operations virtually around the clock-when a day's operations are closing down in the United States, they are just beginning in India. Other reasons companies choose to offshore include the desire to:

• Improve company focus;
• Free up resources for other projects;
• Gain access to world-class capabilities;
• Access resources not available internally;
• Accelerate reengineering benefits;
• Reduce time to market; and
• Remain competitive.

The decision to choose offshoring is creating its own momentum. Because of the large number of firms that are offshoring their work, other firms are also being forced to choose this option in order to remain competitive.

Finally, by offshoring non-core functions, management can improve company focus and concentrate clearly and effectively on "core" function areas. When done correctly, offshoring can allow management to focus on those core functions that give them a competitive edge and have the highest potential returns. Financial institutions are already outsourcing many non-core job functions and are reviewing the prospects of outsourcing all non-core functions, which include:

• Information technology (IT), specifically programming;
• Administration;
• Human resources; and
• Contact centers/Call centers/Telemarketing.

The percentage of institutions running offshore functions is predicted to increase dramatically within the next few years. Further, the range and number of job functions within individual institutions that will be offshored is expected to increase, with the average number growing from two to four functions per institution. The traditional focus on IT alone, which accounts for 70 percent of the current movement of offshore activity, will evolve toward a business-process emphasis.

³ Deloitte Consulting (2003)

⁵ Conference call with Gartner Group on April 29, 2004 .