A Bank's Reputation, Trusted or Tarnished?

Federal Reserve Governor Sarah Bloom Raskin*

Reflections on Reputation and its Consequences

Good afternoon. I want to thank the Federal Reserve Bank of Atlanta for inviting me to join you for today's 2013 banking outlook discussion. There are a number of interesting and very relevant topics on your agenda, most of which are rightly focused on the financial and regulatory environment. I would like to share some thoughts this afternoon on a broader topic, however, that may be due for a refreshed look: the relevance of a bank's reputation.

Let's start in an elementary way in constructing a concept of reputation: We know that reputation is not entirely a moral trait. We understand that there is a distinction between character and reputation. When we say that someone shows good character, we are usually referring to something at the core of their being or personality. On the other hand, when we refer to a person's reputation, we recognize that reputation is our perception of the person, that it is externally derived and not necessarily intrinsic to that individual. In other words, we understand that a person may not have complete control over the perception that has been created. Reputation, through no fault of one's own, can be tarnished. In the same way, one's reputation can be golden, even though nothing was done to earn it. But like the notion of character, reputation can be earned and it can be a type of stored value for when challenges to one's own reputation come later.

Now let's bring this distinction into the context of banks: Many bankers have a sterling character, and they operate financial institutions with sterling reputations that reflect that basic character. At the same time, there are bankers who, regardless of their personal character, manage financial institutions with reputations that have been tarnished. Their banks' reputations could have been tarnished by almost anything, but likely most tarnish is attributable to the subprime mortgage meltdown and the ensuing financial crisis that cost the economy trillions of dollars; left millions of Americans bankrupted, jobless, underemployed, or homeless; triggered massive litigation; and shook the confidence of our nation to the core.

Many of the darkest manifestations of the financial crisis have finally begun to diminish: the boarded-up homes with overgrown lawns, the half-built skyscrapers, the "We Buy Houses Cheap" signs planted at exit ramps, the eviction notices nailed to front doors. But even as the economy comes back to life, our memory of these events is still sharp and the reputational damage suffered by U.S. financial institutions during the crisis endures. To be blunt, a lot of people have negative feelings about banks, which they distrust and blame for the huge infusions of taxpayer money into the financial system that were deemed necessary during the crisis.

These reputational consequences — whether justified or not — are to be expected. Sociologists and economists have long remarked upon the central role that social trust plays in healthy markets. Market transactions depend on a whole series of assumptions that people must be able to rely on, including the soundness of money, the enforceability of contracts, the good will of their partners, the integrity of the legal system, and the common meanings of language. Social trust is the glue that holds markets and societies together. In the context of banking, social trust and reputation are related concepts.

Banks themselves — in crisis or not — are particularly vulnerable to reputational consequences because of their public role. The principal social value of financial institutions is their ability to facilitate the efficient deployment of funds held by investors (and entities that pool these funds) to productive uses.¹ This value is maximized when the cost to the entity putting capital to work is close to the price demanded by the entity that seeks a return on its investment. In traditional banking, this means that financial intermediation occurs most effectively when the interest rate charged for use of funds in lending is close to the interest rate paid for deposits. As the difference between the two grows (which would be attributable to amounts extracted by intermediaries as compensation for essential intermediation), the costs of borrowing for the purposes of creating productive projects become higher than they should be, with arguably negative reputational consequences.

Given these particular reputational dimensions associated with financial institutions, might financial regulators have an interest in considering reputational harms analytically? Could there be benefits to understanding the ways that an individual financial institution's reputation — or that of the financial industry as a whole — might have particular effects on, for example, safety and soundness, financial inclusion, or financial innovation?

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A Bank's Reputation, Trusted or Tarnished?

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