Regulating Bank Reputation Risk
83 Pages Posted: 25 Apr 2019 Last revised: 30 Mar 2020
Date Written: August 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). As part of Operation Choke Point, a federal regulator told banks to end relationships with payday lenders be-cause those activities posed “reputation risk.” Another federal regulator warns banks their reputations might be damaged by lending to oil and gas companies that are perceived to cause environmental harm. Reputation risk is the risk that bank stakeholders will negatively change their perception of the bank. It was almost unmentioned in banking regulation until the mid-1990s, but as these examples illustrate, it is now ubiquitous.
This Article surveys reputation risk guidance and enforcement efforts. It shows reputation risk regulation is usually an ancillary consideration to credit risk, operational risk, or other primary risk. In these instances, reputation risk adds little because regulators have strong tools to address the root problems. Sometimes, however, regulators justify guidance or enforcement primarily in terms of con-trolling reputation risk. Regulators use reputation risk to weigh in on hot-button political topics afield from bank safety and soundness like gun rights, payday lending, and fossil fuels. Because regulators believe reputation risk is present in every facet of banking, little prevents them from using it to address other controversies.
This Article argues expansive regulation of reputation risk is harmful. There is little evidence that regulators can 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