Regulating Bank Reputation Risk
63 Pages Posted: 25 Apr 2019
Date Written: March 16, 2019
In the aftermath of a school shooting in Florida, the New York State bank regulator urged banks to manage the “reputation risk” posed by doing business with the National Rifle Association (a gun rights advocacy group). Reputation risk is the risk that bank stakeholders will negatively change their perception of the bank. Reputation risk was almost unmentioned in banking regulation until the mid-1990s, but now it is ubiquitous.
This Article is the first to examine the regulation of bank reputation risk. It surveys regulatory guidance and enforcement efforts. It shows that most reputation risk regulation is not driven by reputation risk itself. Instead, reputation risk is an ancillary consideration to credit risk, operational risk, or other primary risk. In these instances, reputation risk regulation does little work because regulators already have strong tools to address the root problems.
There are, however, instances where reputation risk is the primary justification for guidance or enforcement. Regulators have already used it to weigh in on hot-button political topics afield from banking regulations like gun rights, payday lending, and fossil fuels. Little prevents regulators from using it to address other controversies. Regulators recognize few limits on their power over reputation risk. They say that reputation risk is present in every facet of banking. It can be triggered by untrue public criticism of a bank or third-party conduct unrelated to banking. Regulators even identify themselves as stakeholders whose perceptions drive the risk.
This Article argues that expansive regulation of reputation risk is harmful. There is little evidence that regulators will be able to accurately predict and prevent bank reputational losses. Moreover, because reputation risk is largely subjective, regulators can use it to further political agendas apart from bank safety and soundness. Unnecessary politicization of banking regulation undermines faith in the regulatory system and correspondingly erodes trust in banks.
Keywords: reputation, risk, bank, regulation, FDIC, NCUA, OCC, Federal Reserve, guns, fossil fuels, payday loans
JEL Classification: K20, K23
Suggested Citation: Suggested Citation