Reputation Risk:
Achieving Heightened Standards

This supervisory definition of reputation risk seemed straightforward enough when it was rolled out nearly thirty years ago. Negative publicity can trigger material safety and soundness risks. But by the time heightened standards were defined a decade later, debate lingered about whether reputation risk belonged in bank risk frameworks at all.

Why? Some argued that reputational risk reflected consumer reactions to other risk failures. By keeping compliance, operational and financial risks under control, reputational risk simply would not materialize. Others argued that banks over the years have absorbed material brand and financial damage from any number of negative news cycles ranging from TARP II and Occupy Wall Street to junk fees and recidivist banks.

Silicon Valley Bank settled that debate. With a single press release, SVB triggered a wave of destabilizing Wall Street short selling and devastating Sand Hill Road tweets. The resulting $42 billion, one-day run prompted both the resolution of SVB and emergency measures by federal regulators to short-circuit spillover systemic financial risks.

The threat of reputational risk

For banks, significant shifts in consumer perceptions about the brand and its products represent tail risk – low-probability, high-impact events that can devastate brand equity and inflict lasting material damage to sales, market share and earnings.

While prudential regulators acknowledge that reputation risk is “less developed” than the other core risks, reputational risk management is critical for banks. Boards and senior management are still expected to integrate reputation into strategic decisions under heightened standards compliance guidelines. So what would be required to meet those supervisory expectations?

Key components of a heightened risk framework include the ability to identify risks, define risk thresholds, and determine risk appetite. Foundational data should be forward-facing. And because reputation is an interdependent risk, a reputation risk framework ideally would generate actionable insights to manage corresponding capital and liquidity risks. For large banks, the most severe risk being a run. Let’s break these down:

• Risk identification: On any given day, less than one in ten consumers will hear something meaningful and memorable about a bank, either from the news, social media or talking with friends or relatives. When big news breaks, though, that percentage can spike to 50% or more. We can identify reputation risks by isolating the types of news stories – what an economist would refer to as narratives – that move the needle with consumers.
• Risk threshold: Most banks, to some extent, rely on media monitoring to estimate the reach and tonality of negative news and corresponding reputation risks. But media monitoring and social media listening data cannot be trended forward. Today’s news coverage is not predictive of tomorrow’s coverage. Brand tracking, on the other hand, produces reliable metrics that quantify shifts in consumer attention and media buzz. Statistically significant risk thresholds can be set, and the data can be trended forward if the thresholds are breached.
• Risk appetite: It’s easy for bank executives to say their institution has zero appetite for reputation risk. But banks that report earnings, offer up CEO interviews or face regulatory or legislative scrutiny are by definition taking on risk. Because reputation is an interdependent risk, risk appetite should not be pegged to shifts in consumer perceptions, but to significant impacts on customer acquisition and attrition, along with material impacts on capital and liquidity.

Beyond Heightened Standards

Regulators have long voiced frustrations that both banks and exam teams tend to manage reputation risk reactively, when a crisis occurs. Meanwhile, a case has been made that public officials have used reputation risk as a lever to advance political agendas, and in the process inflicted reputational damage on large-bank brands. The narratives matter.

By shifting from less reliable media metrics to highly reliable brand tracking data, banks can more effectively monitor reputation risks, measure risk thresholds and mitigate breaches in risk appetite. A heightened standards reputation risk framework becomes especially critical to manage what PR would call a crisis -- what economists would call a shock. Using this approach, banks can generate actionable insights to navigate:

• Shock life cycles: Based on an analysis of dozens of news-driven shocks, four discrete phases have been identified – Respond, React, Recover and Recalibrate – that inform media relations and marketing initiatives, along with the need for pricing adjustments critical to maintaining market share. The predictive life cycle informs what to do, and when to do it.
• Shock severity: Not every negative news cycle is a PR crisis, and not every PR crisis is a shock. The severity of a shock ranges from a highly negative news cycle – a PR crisis – to material brand and financial impacts. Identifying severity levels during the news cycle is critical to mitigating the damage.

Clearly, there is work to be done to elevate reputation risk management. In its post-mortem to the First Republic Bank failure, the FDIC signaled that large banks may be required to monitor their reputational risk profiles in real time. Bank share prices, short seller activity, and social media discussions, though, will only confirm what is already obvious – news has triggered a shock that has elevated the risk of a devastating run. At that point, reputation risk often gives way to resolution planning.

To proactively mitigate reputational risk, banks can efficiently stand up first-line communication research by adapting existing media monitoring and brand tracking tools. Second-line risk can quantify risk thresholds and enforce risk appetite. Third-line audit screens can ensure enterprise alignments that bridge media relations, marketing, finance, investor relations and risk.

Interested in elevating your bank’s reputation risk management and reputation risk framework? We can help.