Mitigating reputational risk in financial services

October 2022  |  FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

October 2022 Issue

Among the litany of risks facing firms in the financial services (FS) sector, reputational risk is often underestimated. Reputation is pivotal to a firm’s standing within the industry. It is a fragile asset that forms the basis for trust, customer and employee loyalty, business partnerships, transaction volume and, ultimately, earnings.

A positive reputation can mean higher customer acquisition and retention rates. According to a study by the World Economic Forum, on average more than 25 percent of a company’s market value is directly attributable to its reputation.

Without sufficient focus on reputation, firms may suffer. FS firms need to forecast and evaluate their reputation risks, and identify procedures to avoid or minimise their impact. This process helps banks shape public perception of their products, services and brand in ways that build consumer trust.

“Reputational risk for FS firms is associated with the possibility of loss in the going-concern value of the firm, including any negative impact on their customer base,” explains Michael Ruck, a partner at K&L Gates LLP. “Reputational risk is related to a firm’s strategy, how it approaches conflicts of interest, individual professional conduct, compliance and incentive policies and the corporate culture. While it may be easier to track market-related risks, reputational risk is often harder to track due to poor data and limited usable metrics.

“FS firms have the twin pressures of having to achieve positive outcomes in both market performance and corporate conduct,” he continues. “Firms may find that being too compliant in meeting societal and regulatory requirements runs the risk of their market performance being poor. While regulators may not agree with this, firms inevitably have to deal with this tension.”

Uncertainty

For FS firms, times of crisis can raise the threat level. The global financial crisis, for instance, gave rise to considerable reputational risk for FS firms, many of which faced strong criticism in the media. This in turn led to public pressure to institute mechanisms for cultural, regulatory and legislative reform throughout the industry. Many FS firms initiated cultural changes to counteract the criticism and to mitigate the reputational damage they experienced.

Currently, the world is in another period of financial instability. With rising inflation and interest rates, geopolitical tensions, energy supply problems and continued unpredictability stemming from the coronavirus (COVID-19) pandemic, among other factors, FS firms may see increased exposure to potential reputational risk.

Negative impacts can be caused by a variety of events at an operational level, such as fraud, corruption, environmental crime, company behaviour, lack of transparency, integrity issues and inadequate crisis management, as well as poor or unexpected financial results.

“Strategic communication can mitigate risk, but communication alone cannot prevent reputational damage,” notes Robert Gemmill, a senior vice president and general manager at Argyle. “Too many companies reactively manage their reputation by turning to their marketing, corporate communication and PR teams to message their way out of an issue. The reality is that communication is simply an output of the actions an organisation takes.

“With more than 60 percent of an organisation’s market value now directly attributable to reputation, organisations must treat reputational risk management as the priority it is, just as they would legal, operations, PR, HR and IR,” he continues. “While the trend already has started, leading companies need to shift to a comprehensive strategy that actively manages their reputation across all key verticals. Companies that do this effectively will achieve more stable valuations, fewer operational liabilities, productive and engaged employees, confident boards of directors, and satisfied stakeholders – especially in periods of economic uncertainty.”

Metrics for reputational risk can, however, be elusive. Quantifying it can be complex, primarily because many of the necessary data sources required are external and unstructured, and often lack a guarantee of quality and integrity. But being able to quantify a reputational risk in real time can allow an FS firm to execute a successful mitigation strategy or activate a full-blown crisis response, as necessary.

According to Andrew Blanchette, director of data intelligence at Argyle, the natural predisposition in the FS sector is to rely on whatever data is available to make an informed decision, which lends itself well to the application of social and data intelligence. “This communications discipline involves aggregating, gathering, analysing and contextualising publicly available social and traditional media data to make informed, strategic decisions,” he says. “Having the ability to quickly tap into these datasets provides essential insight into a company’s risk profile, and how a certain issue or topic is tracking within the court of public opinion.

“This starts with clear communication,” he continues. “There will always be details that cannot be shared, or answers unknown, but when leaders have regular conversations about the direction of the firm, how they will get there, and the important role of employees in that process, internal trust increases. Likewise, in cases where employees have direct and open lines of communication with clients, policyholders and customers, directionless or frustrated employees can quickly raise concerns among external stakeholders. Both can have a tangible impact on external reputation.”

Risk culture

Firms need to consider their risk culture, particularly as regulators have increased their focus on this area in recent years. The Financial Stability Board, for example, has issued a framework for assessing risk culture, while the European Central Bank has issued guidelines on sound remuneration policies and a supervisory statement on governance and risk appetite.

Problems with risk culture and risk management can spark reputational risks which, at their worst, degrade trust in individual FS firms or even the financial sector as whole. A sound risk culture cannot prevent all undesirable behaviour, but it can reduce the frequency and impact of losses that may be linked to it. It can also help to shore up public confidence in the sector.

“If the corporate culture is questionable, this can have a catastrophic impact on a company’s employees, senior management and market value,” warns Mr Ruck. “The metrics against which conduct is measured are the values of society at the time the actions are being reviewed, which in itself inevitably includes an element of hindsight. Societal values and expectations change over time, are different across cultures and are sometimes unclear.

“Firms which push such values to the limit, or go beyond them – for example through compensation and promotion practices – run the risk of encouraging a culture and behaviour which can cause significant reputational damage,” he adds.

Risk resilience and mitigation efforts

FS firms can take a number of steps to manage reputational risk. One of the most important is to institute a clear, formalised risk management plan. By employing a standardised approach to risk management, organisations can identify systemic or operational issues that may affect them, prioritise those risks, then allocate the time and resources to managing them.

According to Megan Gabriel, a senior vice president at Argyle, the best way to reduce reputational risk is to build risk resilience. “Every company – especially those in a fast-paced industry like FS – should embrace being in a constant state of transformation,” she says. “That does not mean that every strategic, operational or cultural evolution is ground-breaking. But FS firms must be able to foresee and prepare for future challenges while also proactively seizing opportunities.

“While there are many risks facing FS firms that are out of any one organisation’s control, that does not mean you cannot prepare for the challenges and risks associated with economic downturns, inflation, and the resulting restructurings or organisational changes. Any time you can be in the driver’s seat instead of reacting, you can lessen the risk of a potential significant impact on your reputation,” she adds.

Another step is to introduce or improve customer experience management, using multiple customer-focused methods. In many respects, customer satisfaction is at the heart of reducing reputation risk for FS firms, and typically results in higher customer acquisition and retention.

As Mr Ruck points out, FS firms can reduce the reputational risk they face by managing customer expectations and perceptions, putting in place appropriate systems to address conflicts of interest and ensuring their culture is not one which puts market performance above everything else. “While firms may find it difficult to monitor or control some reputational risks – for example third-party ethics, challenges from competitors and external hazards – they should be able to manage risks such as regulatory compliance, employee behaviour and executive misconduct,” he says. “Some firms are investing in technology, such as analytical and brand monitoring tools. Others are putting in place crisis management and scenario planning protocols.

“The key is to ensure senior management are responsible for managing reputational risk, and that the importance of this is built into the culture of the firm,” he continues. “Strong ethical policies which are complied with by everyone at a firm will go a long way to illustrating the firm’s expectations and enhance trust in the eyes of customers and shareholders.”

One area of potential risk that continues to gain momentum is environmental, social and governance (ESG). Managing ESG-related risks will evolve in the coming years as those issues become more central to the thinking of customers, investors and regulators globally. “ESG has been more fully adopted in the US and we are now seeing this become an increasingly important issue for FS firms elsewhere,” notes Mr Ruck. “The FCA has stated openly that it is committed to helping investors put ESG matters at the heart of their investment decisions. Similarly, corporates have committed to the ESG ethos and often will seek suppliers and partners who have expressed the same commitment,” he adds.

Ultimately, the risk landscape is always shifting and FS firms need to be ready to move with prevailing trends. “Additional factors include the impact of remote working, scenario planning for further pandemics, increasing interest rates, and the increasing wider financial cost of operating a firm,” adds Mr Ruck.

Reputational risk management will remain critical in the years ahead. A solid reputation can attract and retain customers, employees and investors, as well as help firms withstand setbacks and crises. In contrast, events or circumstances that tarnish reputation can have a dramatic, lasting effect on an organisation’s health.

As such, FS firms will need to improve their capabilities. Conducting effective reputational risk analysis can help identify vulnerabilities and lingering areas of risk. By factoring reputation risk into the wider business strategy and investing in the right resources, firms can significantly reduce their downside exposure, and create a path to continued growth and success.

© Financier Worldwide

BY

Richard Summerfield