An assessment of reputation- and conduct risks in banking: a four-point approach

Abstract

The primary objective of the study was to evaluate current reputation and conduct practices in the international banking environment in order to construct a four point matrix to be used to measure and manage reputational risk. This was to be supported by secondary objectives, which include, but are not limited to, clarifying of concepts, the examination of misconduct regulation and its impact on reputation. All this was done in article format. The first article titled "Banking competition and misconduct: how dire economic conditions affect banking behaviour" aimed to demonstrate the manner in which dire economic conditions impacted competition, performance, risk taking and conduct. This was done by detailed analysis on the various financial industry scandals, which include, but are not limited to, the credit crisis (2007/09), the Libor and Euribor scandals, the Payment Protection Insurance scandal and the Foreign Exchange Markets scandal. The literature review was completed with the manner in which competition, misconduct and fines imposed in these banks had been connected. From the literature study, four propositions were formulated, namely (1) Difficult financial times could result in increased competition; (2) Increased competition may result in increased risk taking; (3) Risk taking levels could have an impact on a bank's financial performance; and (4) Decreased financial performance may result in increased misconduct. It was found that dire economic conditions may lead to increased competition, increased competition may lead to increased risk taking, increased risk taking may have an impact on a bank's financial performance and decreased financial performance may lead to increase in misconduct. The second article titled "Dodd-Frank and risk taking: reputation impact in banks, aimed to demonstrate to what extent the current legislation might have had on the risk taking of six preselected international banks. The legislation analysed included the Glass-Steagall Act, the Gramm-Leach-Bliley Act and the Dodd-Frank Act. The literature review to follow analysed the correlation between risk taking, uncertainty and reputation and led to the formulation of three propositions, namely (1) Current regulatory supervision (Dodd-Frank Act) might not limit risk taking (measured by z-scores) in the banking- and financial industry sectors; (2) Risk taking (measured by z-scores) might have an impact on the market value (measured by share value) of a bank or financial industry; and (3) The market value (measured by share value) of a bank or financial industry might reflect its reputation. It was found that current legislation might have a desired result on risk taking, risk taking might not have an impact on market value and reputation might have an impact on market value. The third and final article titled "Assessing reputational risk: an international four point matrix", introduces a reputational risk assessment technique comprising four key points, each forming the basis against which reputational risk can be assessed, both locally and internationally. The key matrix co-ordinates (who/where/what/how) together form a reputational 'assessment tool kit'. This risk assessment technique may be used in any institution, but financial institutions provide the focus in this work, principally because of the R20bn fine imposed on seven major international banks (Bank of America, Royal Bank of Scotland, Morgan Stanley, Citibank, JP Morgan, UBS and Barclays) for rigging foreign exchange rates just two years after they were caught rigging the world's most important interest rate, Libor. The matrix comprises four key aspects (who, where, what and how) and each assesses the degree of risk posed to reputation. A retail bank, used to determine the effectiveness of the implementation of the matrix, was found to exhibit a high quality jurisdiction with elevated levels of international compliance. From the who and where perspective, no clear evidence of reputational risk was indicated; for the what and how, minimum reputational risk was detected. A suggestion is made to invest in IT systems to strengthen financial institutions' knowledge of their clients. Financial institutions' reputation and the management thereof impacts the vast majority of individuals because so much damage has already been done. A good reputation can increase customer confidence in products or advertising claims, increase customer commitment, satisfaction and loyalty. It is not surprising that maintaining and increasing corporate reputation has become a crucial management objective for globally operating firms. A reputational assessment technique such as the one proposed here should enable a company to be proactive and adequately track (and thereby improve) their reputation.