Reputational Risk Management – The ‘Nuts and Bolts’ 2

Risk Frontiers Africa 2017 – Round Table invitation
February 23, 2017
Managing Reputation Risk
March 24, 2017

Reputational Risk Management – The ‘Nuts and Bolts’ 2

Basel Committee of Banking Supervision (2009) states   that “reputational risk can be defined as the risk arising from negative perception on the part of customers, counterparties, shareholders, investors, debt-holders, market analysts, other relevant parties or regulators that can adversely affect a bank’s ability to maintain existing, or establish new, business relationships and continued access to sources of funding.

SOURCES OF REPUTATIONAL RISK

Risk Interconnectivity

Reputational risk behaves in an interconnected manner with respect to other risk types. While several risk types (credit, operation, strategic & legal etc) can jointly and/or individually give rise to reputational risk, in the same way reputational risk can lead to chain reaction of other risks.

Perception

Perception is the biggest driver for reputation among the public. For instance, according to Business Day of 25th February 2017, a recent survey carried out on the Nigerian insurance industry by Agusto & Co, found that up to 138 million people in Nigeria, Africa’s biggest economy are suspicious of the insurers. Nigerians’ mistrust of this industry is a factor that has caused a low insurance penetration in the country.

Social Media

Social media is other major source of significant risks to reputation. The scale and profile of social media networks have grown(from 1billion users  to over 2 billion between 2010 & 2015) both in terms of customer demographic and geographical reach, thereby these networks can be used as powerful broadcasting tools with the capability to reach large numbers of people in a very short timeframe.  Traditionally, bad news travel faster than good news, therefore the threat of social media to reputation risk management is substantial.

Internal events

Internal Events play a major role in the rise of reputational risk since it has the potential of snowballing into systemic risk if not checked. This situation arises when an organization behaves in a manner that is not consistent with the values or standards laid down, thereby damaging stakeholders’ perception.  A recent example is the infraction by some of the capital market operators in Nigeria who ‘threw caution to the wind’ and engaged in sharp practices/ insider dealings leading to losses of billions of naira by the investors. These cases were vehemently dealt with by the regulators mainly in order to nip the ‘brewing’ reputational crisis in the bud and prevent it from becoming a systemic issue.

Another example is the case of two major airlines recently taken over by AMCON in Nigeria. One school of thought believes that the two airlines behaved in ways that betrayed all acceptable norms in the airline industry standard especially as indiscriminate and frequent cancellation of flights were concerned.

This gave them massive reputational damage to the extent that an average Nigerian executive was no more encouraged to take their flights for fixed appointments within Nigeria. What is the point in booking a flight for a 10am appointment in Abuja from Lagos when you are not very sure of getting there by 2pm? These shortcomings (according to the school of thought) were usually accompanied by no reasonable excuse or apologies from the organizations. These corporate nonchalance and other similar issues were seriously taking toll on the reputation of the airlines (but the organizations seemed unaware), cumulatively leading to their financial distress and eventual take over.  Therefore reputation infractions usually begin from inside before being noticed outside.

Industry association

Reputational risk could be due to association with someone or an act of others or being part of the same sector or business line. When a large US based investment bank (reputed to be strong in risk management), revealed a surprise trading loss of USD 2Bn, it not only affected its image but other banks’ reputation as well. While its shares dropped 7%, other bank shares suffered heavy losses. This is one of the reasons for classifying some organizations as TBTF (Too Big To Fail). Such organizations have spread so well and have garnered enough goodwill over the years that if allowed to fail, the whole system will suffer as a result of the reputational damage. The government would rather support than allowing them to fail, every other thing being equal, just to prevent the consequence of the failure from spreading to the remaining part of the industry. The recent CBN intervention in the Nigerian financial system is an example.

Poor coordination of decisions made by different departments

Poor coordination may manifest in form of unhealthy internal competition. There are cases where two relationship managers from different branches of the same bank would ‘fight’ aggressively by deploying weapons of lies and subterfuge just to win the same account for the same bank. While one promises 24% interest on facility, the other would promise a lower figure of 21% leaving the customer confused about whether these officers are actually from the same bank!

Also as regards poor coordination of decisions, if one department creates expectations that another group fails to meet, the company’s reputation can suffer. Examples are where bank’s ‘marketing’ staffs go out to woo customers with a promise of delivering an almost impossible service (eg issuing MC or bank draft within five minutes) or granting facilities within two weeks of opening account  whereas the other departments (Credit Assessment, Credit Administration, Operations etc) are not carried along and the bank credit and operation policies forbid such arrangement. Therefore such promises are bound to be inoperative and would affect the institution’s reputation adversely. Many account officers and relationship managers, in a bid to achieve their targets are fond of over promising clients even when they know that the final approvals are beyond them. This is what happened in a case where Mr  Layode approached his bankers for a loan when setting up a ‘Bottled Water’ manufacturing company. The branch manager explained that the facility would have to get to the Regional Head Office for final approval but assured the client that this (approval) would be a ‘mere formality’ if the customer could get regulatory (NAFDAC) approval. The customer, relying on this assurance source for fund from other sources to get the NAFDAC approval and the loan was processed at the branch but later declined at the Regional office. In fact, it was observed that the loan, ab-initio, did not meet the criteria for Regional Office approval at all and could not have been approved under any circumstances.  The customer could no longer bear this so he approached the court and succeeded against the bank on the basis of the bank’s liability for tortious negligent misstatement under the principle established in Hedley Byrne V Heller & Partners.  Reference: Box V Midland Bank 1979.

Therefore in order to prevent reputation risk from crystallizing, isn’t it better to ‘under – promise’ and ‘over –deliver’ rather than vice versa?

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