So, while reputational risk is not a new concept by any means, it is an area that is ripe for additional work. For example, the enterprise risk management framework of the Committee of Sponsoring Organizations of the Treadway Commission — the so-called "COSO standard" — does not address reputational risk. Likewise, the Basel capital frameworks exclude reputational risks from regulatory capital requirements.7
Accordingly, the current approach to managing reputational risk is largely reactive rather than proactive. Banks and examiners tend to focus their energies on handling the threats to their reputations that have already surfaced. This is not risk management; it is crisis management — a reactive approach aimed at limiting the damage. Instead, we should think about a supervisory approach that incentivizes bank managers to sufficiently contemplate, quantify if necessary, and control the factors that affect the level of such risks before they fully emerge in an unmitigated form.
The way that the Federal Reserve supervises banking organizations may help identify risks sooner. For all banking organizations, the supervisory program here does not simply rely on an annual onsite examination. The Federal Reserve supplements its regular examination activities with a program of continuous monitoring between examinations. One of the key objectives of this program is to identify emerging risks and communicate with other regulators and the banks an updated risk assessment and supervisory strategy based on these risks.
When we contemplate a supervisory approach that illuminates reputational risk, we might be able to more fully uncover the interconnection of risks that certain activities could impose on investors, creditors, counterparties, and taxpayers. In this approach, we would first and foremost need to encourage banks to assess the potential riskiness of particular operations, investments, products, and decisions to their reputations and, ultimately, to their enterprise value. As supervisors, one objective as we work with financial institutions to extract such information would be to try to develop ways of measuring the value of the risks that banks shift onto the financial safety net.
Reputation and Financial Inclusion
There is also a relationship between reputation and financial inclusion, by which I mean the extent to which consumers can participate in a financial marketplace that consists of competitive providers of credit, savings vehicles, and sources of enabling financial information. As policymakers, we must address the perceived trustworthiness of those financial institutions that interact with the public and move the millions of Americans lingering in the margins of the financial marketplace into relationships that provide them with sustainable access to banking and credit, an understanding of how mortgages and credit work, and an understanding of how to create savings.
Data from the Federal Reserve's Survey of Consumer Finances and the Federal Deposit Insurance Corporation's survey of the unbanked and underbanked show that the percentage of families earning $15,000 per year or less who reported that they have no bank account has been increasing steadily for the past five years, resulting in more than 28 percent of these families being unbanked as of 2011.8 Families slightly further up the income distribution scale, earning between $15,000 and $30,000 per year, are also financially marginalized: 12 percent reported being unbanked and almost 26 percent reported being underbanked in 2011.9
There are several potential reasons for these impediments to inclusion. When we examine barriers that individual consumers face in becoming financially included, we uncover trustworthiness and reputation. A Federal Reserve analysis of the most recent Survey of Consumer Finances suggests that the primary reason individuals do not have a transaction account is a simple dislike of dealing with financial institutions.10 If that dislike emanates from the reputation of the particular bank, or the reputation of the banking industry as a whole, policymakers and financial institutions will not be able to enhance financial inclusion without addressing the reputational context.
Reputation and Innovation
I'd like to imagine how the public's sense of well-being might be enhanced by their interactions with financial institutions. If we paid attention to the experiences of consumers as they interact with various segments of the financial marketplace, what could we learn? If we see rigidities or imperfections in that interactive experience, what innovation might we imagine that would not only reduce reputational risk but create something new and potentially advantageous?
Technological innovation was the subject of a recent award ceremony in San Francisco. The winners were companies with names like SoundCloud, GitHub, MakerBot, Techmeme, and Snapchat, all of which presumably do amazing things, although I don't understand exactly what.11 But, evidently, the real buzz at the ceremony was over something much more mundane that I for one have no problem understanding. That buzz was around a pedestrian item — a new and improved coffee cup lid.12 This lid, called FoamAroma, reportedly provides exactly the right set of openings to maximize aroma and recyclability, while minimizing the effects of coffee spurting out too fast. The point here is that the innovator noticed something simple that others had not: many coffee shop employees don't drink their coffee from cups with plastic lids like their customers do, so there was a market need that had not been recognized and then addressed.
Here I am not just talking about the mixed miracle of mobile banking and mobile payments or being able to take a picture of a check with a smart phone and it appearing in my checking account. That's a topic that is amazing in its own right and worthy of a separate speech. I am talking about encouraging banks to pay attention to the banking experiences of their customers and finding process improvements or service elements that may lead to something seemingly mundane but valuable nonetheless.
Some innovators see reputation itself as not just something to be managed, but as a product in and of itself. With buyers and sellers repeatedly and constantly interacting on the Internet, there are "reputation trails" that are being created that, when compiled, give an alternative set of markers about how trustworthy a particular buyer or seller may be. These reputation trails — gathered when you evaluate a product you've bought online or when you deliver the product that you've promised — create a picture of trust that some have argued has value that can be shaped.13
Reputational Risks and Cybersecurity
Perhaps reputation will one day transform commerce. But in the meantime, I would like to mention one set of reputational issues that the banking industry is confronting as we speak. As is the case for reputation trails, it too involves the Internet, but this use of the Internet is not being done in the spirit of cooperation and enhancement of public trust. This set of reputational issues comes in response to the recent substantial increase in cyberattacks, all of which have the potential to undermine the fundamental trust that the public puts into financial institutions.
Cyberattacks on banks are occurring with increasing frequency, and concerted cooperative work between government and financial institutions is underway. Customers are increasingly being affected by the cybersecurity threats that banks face. Recently, distributed denial-of-service attacks have caused temporary disruptions of some web services. In September, the websites of several large banks were rendered inaccessible for several hours from attacks now attributed to possible foreign state-sponsored hackers. One of the greatest threats facing not just banks but many businesses and government agencies is hacking — and the possible theft of proprietary data and personal information about customers.
This cybersecurity threat is increasing at a time when more and more bank customers depend on electronic and mobile banking. Workers are using their own laptops and smart phones or working remotely from home computers, and this increases the entry points to the systems that need to be protected. In addition, customers and vendors are linking their systems, enhancing efficiency, but also creating more opportunities for potential intrusions.
But even beyond the potential theft of data and disruption of service, cyberattacks can represent significant reputational risk because they have the potential to create dissatisfaction among many customers or, even more chilling, total loss of consumer confidence.
Cooperative work between government and industry is underway. Through the Department of the Treasury, many of the affected institutions have requested and received technical assistance from the Department of Homeland Security, which has been helpful in mitigating the attacks. Some institutions are researching new technologies for defense against cyberattacks through their Internet service providers or security vendors, and others are reviewing their incident response processes to better manage recovery time and communications among information technology, employees, vendors, media, and customers.
The Financial and Banking Information Infrastructure Committee, the Financial Services Information Sharing and Analysis Center, and the Financial Services Sector Coordinating Council are serving as the forum through which the financial services sector shares important information and develops critical infrastructure protection policies. Through their coordination, affected institutions and law enforcement agencies can share threat information and mitigation techniques.
In addition, a recent Executive Order issued by the President represents a continued commitment to enhancing the security and resiliency of the nation's critical infrastructure to meet future threats.14
Conclusion
In closing, these have been some of my reflections on reputation as it applies to the business of banks. The concept of trust is relevant to how bankers engage in a business that is of benefit to the public and provides meaningful innovation to the core function of financial intermediation, as well as to how we as supervisors can engage in a process of observation that is forward-looking and of benefit to both the public and the institutions that we regulate.
Thank you for your attention today. I look forward to taking your questions.
*Sarah Bloom Raskin at the 2013 Banking Outlook Conference at the Federal Reserve Bank of Atlanta, Atlanta, Georgia; February 28, 2013. Footnotes
Photograph from Wikipedia: A 2007 picture of a bank run outside a branch of Northern Rock in Birmingham, United Kingdom in 2007, when there was speculation about problems with bank.
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