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REPUTATION RISKS IN BANKING

By RL Expert Leesa Soulodre

With reputation risk flagged as the top risk in 2015 for CxO's and their Boards (Deloitte, 2014) and one of the top 5 Global risks (Allianz Risk Barometer 2015), understanding your own industry's dynamics is a critical necessity for both competitive positioning and protecting your Bank's legal and social licenses to operate.

Reputation and its Risks

Reputation is the image in the mind of our stakeholders. It is based on the level of trust, admiration, respect and esteem that stakeholders have in our company (Fombrun, 2004). In contrast reputation risk is the risk of the loss of this reputation capital. These risks reside in the difference between stakeholders expectations of the company and the company's performance.

Understanding the characteristics of the industry within which the actions of your company and its competitors are observed and interpreted by its stakeholders is 1 of 3 critical signalling components that supports in the forming of reputations. The other 2 contributing factors are the pattern and characteristics of your company's market activities and the pattern and characteristics of your competitors’ market actions (Basdeo et al., 2006).

A Bank's Stakeholders ie. Customers, Suppliers, NGO's, Academics, Investors, Partners, Regulators, Government, Media etc observe these market behaviours based on 7 key drivers (Fombrun, 2010). These form images in their minds about the company.

REPUTATION INSTITUTE - WHAT MATTERS MOST WHEN FORMNG PERCEPTIONS ABOUT A BRAND

Source: American Banker / Reputation Institute Survey 2015

The 2015 Reputation Risk Landscape

A  desktop and database scan of the current reputation risk horizon highlights that 2015 continues to be a very challenging year for the reputation risk profile of the Banking sector. 

UBS, JP Morgan Chase, Barclays, Citigroup and Credit Suisse have all worn the brunt of reputation risks, having the record as the most controversial banks in the sector based on the volume, voracity and volatility of negative stakeholder allegations.

The sector's current 5 top reputation risks are:

  1. Violation of national legislation (i.e. breaking the law) (Governance and Leadership)
  2. Fraud (Governance and Leadership)
  3. Corruption, bribery, money laundering and extortion (Governance)
  4. Controversial products and services (Products and Services, Innovation)
  5. Tax evasion (Governance, Leadership, Workplace).

It is no wonder that Government regulation of the financial services industry is perceived to be too low, with more than half of Edelman's 2015 Trust Barometer respondents believing that there is not enough regulation of the industry. In recent days the UK SFO has been urged to use criminal charges instead of deferred prosecution arrangements against companies accused of these white collar crimes (FT, 26/06/2015).

Profits not Bonuses

Investors are also wanting to hold Banking Executives to account on these critical governance and leadership issues as illustrated by their ongoing concern with executive compensation and incentive schemes. With UBS expanding their incentive pool by 28% to 3.5B this year and Barclays paying out 2.4B in 2013 amidst all the scandals, there is a clear argument that bonuses should not be superior to profits.

Legal and General Investment Management set the trend in 2012, voting against 126 remuneration policies and 22 chairmen at the companies it had invested in. This decision was intended to send a "strong signal to the board" that shareholders would step up their efforts to tackle excessive pay. We are now seeing this stance increasingly being adopted by the wider audience of Asset Managers and Owners. The UBS CEO alone reportedly earned close to CHF 11 million in salary and bonuses, which represents a 20% increase than in the previous year, while the head of the investment bank department reportedly earned 25 million to take on his post at the bank (Inside Paradeplatz, Dec 2014). All while UBS had to set aside CHF 1.8 billion to face US justice over allegations of foreign exchange manipulations and had already spent CHF 1 billion on settlements. The bank also had to pay CHF 1 billion to France to settle litigation involving illicit earnings.

Liquidity Risk

With such significant fines on record, one of the most overlooked risks in the ongoing battle of reputation for these banks is that of liquidity. With French bank BNP Paribas pleading guilty to two criminal charges last year, they agreed to pay almost $9 billion to resolve accusations it violated U.S. sanctions against Sudan, Cuba and Iran. This was a severe punishment aimed at sending a clear message to other financial institutions around the world. This fine had a 97% negative impact on the company's 2014 financial performance

With economic performance a major driver of reputation, 2016 is looking challenging for all Banks as tougher international regulators, stricter capital rules and increased taxation in Europe and other parts of the world, continue to impact earnings.

Controversial investments in cluster munitions, coal fired power stations, nuclear power, mountain-top removal mining and agricultural speculation (RepRisk, 2015) also do little to increase the sectors general attractiveness to both consumers and investors.

Motives for innovation matter more

Although innovations like cyber currency and electronic and mobile payments might be welcomed by consumers, technical issues blocking access to funds (NatWest 27/09/14), misdirection of payments (RBS, WSJ, 17/06/ 2015) and Carbanak's massive cyber attack against 100 international Banks make it a challenge for the Banks to restore trust with their consumers. It is also unfortunate that the motives of the banks for development of new innovations are perceived to be greed and money and business growth targets, rather than a desire to genuinely improve their customers lives or make the world a better place (Edelman, 2015).

The Watchdogs

With international Governments and NGO's including Berne Declaration, BankTrack, Global Witness, the International Consortium of Investigative Journalists and FairFin all keeping a watchful eye on the sector, it will be interesting to see how the individual Banks maneuver to reinstate trust with their stakeholders as regulation rains down upon them.

While Switzerland, the UK and the United States have been the homes for the brunt of Government and Fed actions, other financial markets around the world including Hong Kong and Singapore are monitoring the regulatory landscape and taking proactive action on governance and disclosure standards.

The Business Case for Reputation Risk 

There is a clear business case for the Banks to invest in reputation risk management i.e. potential actions to prevent a reputation damaging event as well as potential actions to moderate the influence of the occurrence of a reputation-damaging event (Rhee and Valdez, 2009).

When it comes to reputation risks it is hard to believe the notion that Banks can be perceived as more legitimate when their actions conform to these current industry norms. Why? Because we know that the stakes are high when a Company gets it wrong (Perry and de Fontnouvelle, 2005). 

Many argue that a fine cannot possibly disincentivise an entire industry when the profits garnered through a business model of money laundering or rate rigging profit a Bank so handsomely when undiscovered. However, I can still recall a significant volume of one particular Bank's assets under management, walking out the door when the announcements of money laundering were made. Employees were eager to jump ship, save being branded as an unethical operator, ratings were lowered, investors dumped the stock and partner institutions increased their lending rates. 

Action and Accountability

While reputation risks have cost the banks billions in poor reputation risk management over the past 5 years, it is interesting to see so few having appointed a Chief Reputation Officer to their Boards or Leadership teams and most importantly one suitably empowered. Even fewer have in place a multidisciplinary Upstream Risk Forum to proactively monitor and tackle these risks. Alas, for many it still sits as a communications and PR effort.Alas lawyers and even the communications agencies are often not incentivised to proactively help a Bank mitigate reputation risks - rather they get paid significantly more when the events happen.

The action plan is clear. For when outrage is high and specific operations that underpin the organisation are inherently corrupt or broken, communications alone is not enough to ebb the tide of fines, consumer and media backlash and loss of shareholder value. Rather an investment must be made in a comprehensive reputation risk management program that includes the appropriate corporate governance measures, cultural transformation, performance and incentive schemes, risk management regimes and sustainability measures. Moreover, an appropriately qualified Chief Reputation Officer with the matrix management accountability and budget should be appointed to address them.

Board Action

For those Banks stuck in a reactive operandi, Board members would be well served to understand 4 basic approaches for reactive reputation risk management:

  • High Outrage + Bad operations = remediate and communicate + crisis communications
  • Low Outrage + Bad operations = remediate and invest in risk communications
  • High Outrage + Good Operations = communicate, communicate, educate!
  • Low Outrage + Good Operations = exploit for reputation leadership

Naturally, all Banks Boards would be better served with a lifecycle management approach to drive proactive reputation risk management. This way they can reduce uncertainty in their strategic planning, select the highest impact issues, gain additional lead time, attune to emerging societal trends and transform trends into opportunities and competitive advantage.

It's an interesting year indeed for the Banks and their reputation risks. It will be interesting to see who starts to get it right and which Institutions will continue to pay the price dearly.

Be sure to watch this space!

Want to know where you are on your reputation journey? Take our diagnostichere and be sure to include a note in your response referencing this LinkedIN post. Learn more here:

http://www.rlexpert.com

Note these statements are based only on publicly available data including Sources from Factiva, DataMonitor, LexisNexis, RepRisk, MSCI, Asset4.

Basdeo Dax K., Smith Ken G., Grimm Curtis M et al.(2006), “The Impact of Market Actions on Firm Reputation”, Strategic Management Journal , Vol. 27, No. 12, December, pp. 1205-1219.

Perry J and de Fontnouvelle P (2005), “Measuring Reputational Risk: The Market Reaction to Operational Loss Announcements”, Working Paper, Federal Reserve Bank of Boston, Boston, MA.

Rhee, M., Valdez, M. (2009): "Contextual Factors Surrounding Reputation Damage with Potential Implications for Reputation Repair". Academy of Management Review 34(1), 146- 168.

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I appreciate that you are reading my post. Here, and at LinkedIn, I write about board related issues - corporate strategy, human capital, reputation risk, technology, corporate governance and risk management trends.

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About RL EXPERT Leesa Soulodre:

Managing Partner and Founder of RL Expert Group, an international reputation and risk management think tank and consulting practice and Asia Associate of the Reputation Institute. A Member of the Global Advisory Council of NY Investment Advisory Firm, Cornerstone Capital; an Innovation Advisor to the University of Illinois Urbana Champaign Advanced Digital Science Centre, Singapore and Board Advisor to Belgian PR Software firm, Prezly and US Sports Analytics firm, Autoscout.

Research Fellow at TIAS - the School for Business and Society, working to deliver predictive reputation risk analytics for financial strategies and complex global supply chains - r3Intell.

Connect: Leesa Soulodre, Managing Partner, RL Expert Group - ls@rlexpert.com

www.rlexpert.com

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