Many vendor management systems focus on stopping the last few dominos from falling. Meaning they try to alleviate damage that has already been done. Not many consider the different stages of risk—outlined below—or the spectrum of ramifications they can cause for any financial institution.
The CFPB’s definition of a financial institution is broader than the industry has previously stated. Anyone involved in a financial activity could fall under this category—even mortgage professionals such as realtors and title agents. If you collect or hold money for consumers, you are within the CFPB’s reach.
It’s Imperative For Financial Institutions of All Sizes To Catch Vendor Risks Before They Start.
Potential Vendor Risk
Potential risk is like the first domino in a line that hasn’t been pushed yet: it has the potential to cause harm to the partnership, but no negative situation, as yet, has threatened to topple it. Any base, initial risk a vendor brings to the table is a potential risk.
Kinetic Vendor Risk
According to Newton’s first law of motion, once a domino starts to move, it creates kinetic energy that stays in motion. When applying this law to the mortgage industry, when a potential risk is set in motion, becomes kinetic, it then creates a domino effect, leading to other kinetic risks without needing the potential-risk stage for a catalyst, thus multiplying the possible ramifications. It also increases vertical momentum by transferring the liability of those ramifications higher and higher up the mortgage chain. Kinetic risk can affect everyone that touches the loan file, from the bank to the servicer and all the way up to the investor.
Do Your Third Party Vendors Pose Potential And/Or Kinetic Risks?
Most of the “potential” risks above result from a vendor’s inconsistency in performing everyday tasks. If the vendor does not regularly review policies/procedures, it’s only a matter of time before that first domino gets pushed toward more dominoes of liability down the line.
Here’s a Vendor Risk Scenario:
Let us illustrate with an example.
It All Starts With Potential 4th Party Risk, Strategic Risk
A settlement agent hires a notary, but neglects to perform proper due diligence and audit their vendor (potential strategic risk, potential 4th-party risk). The notary shows up exhausted, 30 minutes late to the closing table as a representative of both the settlement agent and the lender (kinetic 4th party risk and kinetic reputational risk).
The first domino has been pushed.
Once Vendor Risk Becomes Kinetic, It Becomes Much More Difficult to Manage
The consumer has a bad experience because the notary is too tired to function (kinetic reputational risk). The notary misses certain details and makes mistakes on the form (kinetic data and transaction risk). Most of these mistakes are caught and corrected before the loan closes, but not all of them (kinetic compliance, data, transaction and operational risk).
The Domino Effect Creates Long-Lasting Risk
The loan gets sold to a private mortgage investor on the secondary market. A year later, the CFPB has received several complaints about this notary and investigates the loans they were a part of (kinetic compliance and reputational risk). They ask the lender why the settlement agent didn’t follow due diligence when hiring the notary, the lender’s 4th-party vendor. If the notary was consistently doing shoddy work, yet they were hired anyway, the regulator will have a problem with that.
Though the settlement agent was the one who hired the notary, the lender is held liable because of guidelines set by TRID (kinetic compliance and 4th-party risk). The lender is fined for the TRID violation and the investor is notified (kinetic compliance and reputational risk).
The investor pushes back the entire pool of loans that came from the lender (kinetic credit and transaction risk). They also refuse to do further business with the lender (kinetic reputational risk). The lender cannot afford to lose both the investor’s business and have a bottleneck of mortgage loans sitting on their books for 30-plus years, so they decide to exit the mortgage lending business (kinetic credit and transaction risk).
Catch Vendor Risk Before It Becomes Kinetic
Kinetic vendor risk is where many mortgage-process problems surface, but the issue starts much earlier with potential vendor risk. Mitigating potential risk before it becomes kinetic and damages the mortgage transaction is critical. Avoid the domino effect and know your vendors—before they make you owe.
Want to make your mortgage process easier and more accurate? Contact ATS Secured today.