RBI’s Master Direction on IT Outsourcing: Ensuring Compliance and Building Trust

7 min readDec 14, 2024

It has been more than a year since the Reserve Bank of India (hereafter referred as “RBI”) launched the Master Direction on Outsourcing of Information Technology Services. This was seen as a much needed step as most of the Banks & NBFCs in India have partners, primarily FinTechs, IT service providers, Infrastructure providers, where many of the IT-related functions are outsourced. These “partners” are referred as “Service Providers” or “Third Parties” that manage the IT component or IT enabled services (IT infrastructure management, Network and security solutions, Cloud Computing Services, Application Development, Maintenance and Testing, etc). These Service Providers do not essentially belong to the REs, and are mostly privately owned organisations. This reliance, while offering benefits like cost efficiency and access to specialized expertise, also exposes REs to various risks:

Data breaches and security vulnerabilities: Outsourcing sensitive data to third parties increases the risk of data breaches and cyberattacks as the security controls implemented by the third parties are not the same as the REs.
Operational disruptions: Service provider failures or disruptions can significantly impact REs’ operations and customer service. This also includes operational changes or financial losses of the service providers.
Reputational damage: Data breaches or service disruptions can damage an RE’s reputation and erode customer trust.
Regulatory non-compliance: Outsourcing arrangements may not always comply with applicable laws and regulations, leading to penalties and sanctions.

The Master Direction aims to mitigate these risks by establishing a comprehensive framework for REs to manage their IT outsourcing activities effectively. In this article, we will see all the controls laid down by this direction. The master direction is a 31-page document; however I have tried to include all essential elements from it in this article.

These guidelines are applicable to all Regulated Entities (hereafter referred as REs), including public and private banks, non-banking financial companies (NBFCs), and other financial institutions supervised by the RBI (NABARD, SIDBI, etc).

There are 9 chapters in RBI’s MD on IT outsourcing. Let’s see each in detail. Chapter I is the introduction.

Chapter — II — Role of the Regulated Entity

REs should assess the need of IT outsourcing. REs need to maintain an inventory of service providers and map their dependency on third parties periodically.
REs need to effectively oversee the activities of the service provider, irrespective of it’s location (India or abroad). REs also need to consider all relevant laws and regulations when performing its due diligence in relation to outsourcing of IT services.
REs need to ensure that the service provider, if not a group company, shall not be owned or controlled by any director, or key managerial personnel, or approver of the outsourcing arrangement of the RE, or their relatives.
REs should have a clear grievance redressal mechanism in place to address customer complaints related to outsourced services. E.g. A bank has a service provider for doing KYC of credit card applicants on its behalf. The responsibility of redressal of customers’ grivances lies with the bank and not the service provider.

Chapter — III — Governance Framework

REs should have a robust “IT Outsourcing Policy” approved by their Board, which incorporates criteria for selecting activities and service providers, delegation of authority, and systems to monitor and review outsourced operations. The Board of Directors and Senior Management should oversee the outsourcing function and ensure that adequate risk management controls are in place.
This chapter talks in detail about the role of board of directors, senior management and IT function that supports the first two.

Chapter — IV— Evaluation and Engagement of Service Providers

This is one of the most crucial aspects on this direction that includes Due Diligence on Service Providers.

This mainly revolves around Risk Assessment and Management.

REs must conduct thorough due diligence on service providers, including financial stability, operational capabilities, and security measures.
Ongoing monitoring and assessment of service providers are essential to identify and mitigate potential risks.
The controls should be around, but not limited to the following — experience of the Service Provider in providing such services and performance, financial soundness, conflict of interest, security, internal control & audit measures, business continuity strategies, capabilities to segregate the REs data, security risk assessments, data protection and storage related measures, etc.

REs can ensure that these controls are implemented by conducting timely audits or risk assessments on service providers and also by referring to the assurance reports or compliances by certifying bodies such SOC 1, SOC 2 Type II, ISO 27001–17–18/22301/27701, GDPR, PCI-DSS) etc. to which the Service Provider may be certified/compliant to.

Chapter — V— Outsourcing Agreement

This chapter makes sure that the reliance between REs and Service Providers is a legal relationship regulated by the legal counsel of the RE. Some of the aspects to be considered in the agreement are :

Details of the services being outsourced
Compliance with relevant acts (IT act 2000, DPDPA or other applicable laws).
Material Adverse Events / Incidents : data breaches, data loss, ransomware, DOS, service unavailability, reporting timelines for these and countermeasures taken immediately. This also includes the service provider’s liability in event of a security breach.
Service level agreements (SLAs), contingency plans to ensure business continuity.
Data Storage and Security : data to be stored in India, data elements that can be shared with third-party, non-disclosure agreement (NDA) and clauses related to data capturing, processing and storage. E.g., data needs to be encrypted at rest.
Right to audit/seek information, obligation to co-operate with authorities in case of an incident or insolvency.
Controls around subcontracting and their obligations. Clauses for obligations and arrangements between REs → Service Providers → OEMs. E.g. A service provider operating a lending platform on behalf of a NBFC can use an OEM/third-party for a component like KYC.

Chapter — VI — Risk Management

Risk Management Framework: REs are required to develop a robust risk management framework tailored to their specific outsourcing arrangements. This framework should cover the entire outsourcing lifecycle, from initial due diligence to ongoing monitoring and review.
Risk Assessment: REs must conduct thorough risk assessments to identify and evaluate potential risks, such as data breaches, operational disruptions, and reputational damage. These assessments should consider various factors, including the criticality of the outsourced services, the sensitivity of the data involved, and the service provider’s track record.
Risk Mitigation: Based on the risk assessment, REs should implement appropriate risk mitigation measures. These may include:

Contractual safeguards: Incorporating robust contractual terms and conditions to address potential risks and ensure service provider compliance.

Security measures: Implementing strong security measures, such as encryption, access controls, and regular security audits, to protect sensitive data.

Business continuity planning: Developing comprehensive business continuity and disaster recovery plans to minimize disruption in case of service provider failures.

Regular monitoring and review: Conducting regular monitoring and review of outsourced activities to identify and address emerging risks.

Risk Reporting: REs should establish clear reporting mechanisms to track and monitor the effectiveness of their risk management framework. Regular reports should be submitted to senior management and the Board of Directors, highlighting key risks and mitigation measures.

Chapter — VII— Monitoring and Control of Outsourced Activities

This chapter’s objective is to guarantee that REs have a strong framework in place to recognise and manage any new risks related to outsourcing and to effectively monitor their service providers.

Constant Monitoring : In order to guarantee adherence to the Master Direction, the outsourcing contract, and relevant laws and regulations, REs must constantly keep an eye on activities that are outsourced. This covers routine evaluations of SLA compliance, security posture, and service provider performance.
Internal Audits : In order to evaluate the efficacy of risk management controls, data protection measures, and business continuity plans, REs are required to perform routine internal audits of their outsourcing agreements. Independent internal audit teams ought to carry out these audits.
External Audits: For crucial or intricate outsourcing agreements, REs may also think about performing external audits of service providers or their control environments in addition to internal audits.
Escalation and Reporting : The Board of Directors and senior management must be notified right once of any serious problems or shortcomings found during monitoring or audits. These problems should be addressed with the proper preventative and remedial measures.

Chapter — VIII — Outsourcing within a Group / Conglomerate

This chapter emphasizes the importance of maintaining a consistent and rigorous approach to risk management, regardless of whether the service provider is internal or external to the RE.

Chapter — IX— Cross-Border Outsourcing

This chapter addresses cross-border outsourcing, which involves engaging service providers located outside India. Key considerations for cross-border outsourcing include country-level risks, governing laws, contingency planning, data security and exit strategies (chapter X).

Appendix I of the RBI’s Master Direction on IT Outsourcing provides specific considerations for regulated entities (REs) when using cloud computing services and Appendix II refers to outsourcing of Security Operations Centre (SOC). It emphasizes the need for a risk-based approach and adherence to the core principles outlined in the main body of the Master Direction (the controls that are mentioned above).

The Appendix III refers to the Services not considered under Outsourcing of IT Services.

By emphasizing risk management, data security, and customer protection, the guidelines aim to foster a secure and resilient financial ecosystem. Adherence to these principles is not merely compliance; it’s a strategic imperative for institutions seeking to leverage the benefits of outsourcing while safeguarding their operations and maintaining customer trust in an increasingly digital world.

For any queries, suggestions or comments, do not hesitate to write to me or leave a comment!

References :

https://rbidocs.rbi.org.in/rdocs/notification/PDFs/102MDITSERVICES56B33FD530B1433187D75CB7C06C8F70.PDF
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