Reputational risks and large international banks
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Reputational risks and large international banks Ingo Walter1
© Swiss Society for Financial Market Research 2016
Abstract The paper considers the causes, costs and consequences of reputational risk in large international financial institutions. A conceptual strategic positioning model focusing on clients, products and geographic arenas is superimposed on a flow of funds model based on the key financial intermediation functions. This nexus is used to identify important areas of reputational risk, which are then documented in an inventory of adverse events in recent banking history, and explained in terms of behavior failures in compliance, public expectations and behavioral norms. This framework is then used to position empirical studies of reputational risk in the literature, and a normative discussion of reputational risk governance and bank culture. Keywords Reputational risk · International banking · Conflicts of interest · Bank regulation · Market discipline · Risk governance JEL Classification
G20 · G21 · G28
Based on a presentation at the Federal Reserve Bank of Chicago, Conference on the Future of Large, Internationally Active Banks, November 5–6 2015. Revised version to be published as Walter, I. (2016) “Reputational Risks and Large International Banks” in Demirgüç–Kunt, A., Evanoff, D. D. and Kaufman, G. G. The Future of Large, Internationally Active Banks. Singapore: World Scientific Publishing.
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Ingo Walter [email protected] Seymour Milstein Professor Emeritus of Finance, Stern School of Business, New York University, New York, USA
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I. Walter
1 Lessons from the past Reputational risk in banking and finance is nothing new. It can be found in historical accounts dating at least to biblical times, cementing the “specialness” of banking in the public discourse and engaging thinkers as diverse as Machiavelli, Adam Smith, Walter Bagehot, Frederick the Great and Alexander Hamilton. Damage associated with banking issues tends to spread beyond those immediately involved to the broader economy, and is reflected in episodic booms, busts and panics throughout financial history. In due course, regulation targeting individual firms and the financial system as a whole usually gained traction, ranging from honest dealing and “fitness and properness” reviews of banks and bankers to wholesale constraintbased approaches intended to match the ultimate financial backstop of the general public with the public’s right to set the rules. Privatizing gains and socializing losses in the financial system have never been politically tenable for very long. Fast forwarding to recent times, banking and finance have continued to be dogged by reputational issues. Issues were centered on conflicted equity research, insider trading, late trading in mutual funds, fee kickbacks to insurance brokers, mis-selling complex securities and worthless payment protection insurance, stock clearing for pump-anddump brokerage scams erupted with alarming regularity—in each case eroding the vital trust attribute of the industry. Someti
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