Reputational Risk: Best Practices for Getting It Right

Executive Summary

We see daily demonstrations, in traditional and social media, of how an adverse, potentially criminal event, or even a rumor, may cost a firm revenue, increased operating, capital or regulatory costs, or destroy shareholder value, even when the company is not found guilty. Typically, during the course of such an event, a company’s ethics, safety, security, sustainability, quality, or innovation will be brought into question, tarnishing the firm’s reputation. Leaving customers, regulators, or the general public wanting to punish a firm for unfair practices are all sources of this kind of reputational risk.

At Opimas, we define reputational risk more precisely as the potential adverse impact that arises from operational, credit, regulatory, or market events, where this adverse impact is in excess of the direct losses experienced due to the event, and is amplified by a decline in the public’s opinion of the firm.  This will show up first as a decline in the firm’s market capitalization; later, there will be regulatory scrutiny and client discontent. In the longer run, there will be client defections and revenue declines.

Social media can accelerate and intensify reputational losses forcing firms to fight fires while reassuring investors, clients, and employees that everything is under control.

Financial institutions are in the business of taking intelligent risks with credit and in markets. However, when those risks are mismanaged, firms can find themselves out of business, in court, at a Senate hearing committee, or even worse. Along the way they will encounter operational risks that are simply a cost of doing business. In this new report Opimas explores various innovative techniques that financial and non-financial institutions can use to identify, measure, manage, and monitor reputational risk.

Figure 1. Reputational Risk Impact vs Credit Risk Impact

Source: Opimas Analysis

Contrary to the conventional wisdom, which advocates a single, unified approach, our findings are that managing reputational risks requires a playbook for each stakeholder affected, from clients, shareholders and counterparties to employees, directors, executives and regulators.  Traders, for instance, must understand that the firm has zero tolerance for fraud or negligence. On the hiring front, recruiters and executives must look for candidates who will bolster a culture that adheres to the highest ethical standards. In today’s predominantly service-based economy, a firm’s reputation is of paramount importance. This is true for all businesses, but is especially true for financial institutions, where damage to the firm’s reputation can be ruinous.

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