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Thursday, November 27, 2014

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SRC Insights: Fourth Quarter 2008

How Can a Bank Protect Its Reputation During Uncertain Times?

In the fourth quarter 2007 issue of SRC Insights, I discussed how a financial institution should identify, measure, and mitigate reputational risk. I defined and interpreted it and introduced a few key elements for managing reputational risk. One important point was understanding how a financial institution's reputation can be tarnished. The demise of Northern Rock, Britain's first bank run in 140 years, was used as an example of this. As liquidity dried up both here and throughout the world during last summer's global credit crisis, word leaked out that Northern Rock had approached the Bank of England to obtain emergency funding as customers withdrew billions in currency. Northern Rock became a victim of reputational risk. I concluded that article by stating that reputational risk is regarded as the greatest threat to a company's market value.

Fast-forward 12 months later, and so far this year, two government-sponsored entities, three investment banks, and an insurance and finance company all have fallen victim to the Wall Street crisis. Focusing on the banking industry, at the time of this writing, 17 banks have been taken over by the FDIC so far this year—more than the previous five years combined and the most since 1992.

This article adresses how to protect your institution's reputation in bad times. Many factors create and influence an institution's reputation, including financial performance, corporate governance, code of ethics, regulatory compliance, communications, culture, and crisis management. Crisis management is a key issue during difficult economic times.

Most banks have typically been reactive rather than proactive when faced with bad news that could hurt their reputation. In other words, the concern for an institution's reputation usually comes as a response to a negative event, rather than from planning and implementing a program proactively.

This past summer, $32 billion Indy Mac Bank's collapse was indirectly caused by a deposit run that began and continued after a public release of a letter to the banking agencies that expressed serious concerns about Indy Mac's future viability. As thousands of customers were withdrawing their funds at Indy Mac, investors throughout the country were dumping the stocks of many other banks. One of the biggest fears of banks was that depositors, seeing what was happening on Wall Street, would begin to remove their funds. This could create liquidity problems very quickly for even reasonably healthy banks.

Recently, several major insurance companies saw their values shrink with a huge sell-off in insurance stocks due to a U.S. Congressman's comment on "a major insurance company, one with a name that everyone knows, that's on the verge of going bankrupt," according to Dow Jones newswires.1 Several insurance companies were forced to do damage control by issuing press statements to dispel the notion that the rumor was about them.

It is well-known that a company's reputation can be a delicate thing; even the slightest tarnish can affect your customers' and shareholders' perception and result in reduced business activity and, ultimately, a lower share price. Not having the right systems in place to react can turn a small issue into a full-scale reputation disaster. Financial institutions throughout the country are starting to focus more attention on protecting their reputations during turbulent times.

The following list offers a few high level suggestions on how to protect your institution from a possible reputation crisis. Granted, small community banks may not be able to afford the infrastructure to manage a crisis like larger institutions, but the message should be abundantly clear: there's not much time to waste in fixing the issue that caused the reputational risk.

  1. First, it is critical that an effective communications policy be in place, which includes the processes for tracking and responding to the issues effectively. The policy may include a system for maintaining effective communication among shareholders, the board of directors, employees, and customers. Each group must be quickly apprised of any critical event.
  2. The communications policy should also outline roles and responsibilities. Establish a crisis management team to react to any negative event that impacts your organization.
  3. It is essential to have a bank spokesperson to conduct media interviews with a prepared written statement. This will ensure that your spokesperson does not deviate from the intended message.
  4. A question and answer document should also be prepared, setting forth your bank's stance and providing strict guidelines for your bank's comments, to ensure that one clear and concise message is communicated.
  5. Honesty is the best policy. Be open, but never admit liability or speculate.
  6. Keep the statements simple and factual, covering why the issue has surfaced and what the organization is doing about the issue.
  7. Along the same lines, ensure that your organization's statements are easy to understand so there is little chance to be misunderstood.
  8. Whatever the issue, the organization must react to it from the start. An institution is more likely to lessen potential damage and achieve a favorable outcome if it takes appropriate action early on.
  9. And finally, ensure that there is a system in place to record approvals for any documents that are issued publicly. Keep a record, and ensure that only approved and properly trained staff speak to the public.

So, what should an institution do when faced with bad news? Institutions of all sizes can work to address the issue that has caused a reputational risk by following these three Cs:

  1. Commitment: The institution must lay out—in detail—what it intends to do and commit to resolving or addressing the issue.
  2. Communication: The institution must react to and be ready to acknowledge the issue and effectively communicate with its customers, employees, and shareholders.
  3. Control: The company spokesperson must show that the bank is in control of the situation and is working with the relevant parties to ensure that it will not happen again.

Remember, reputation is one of your most important corporate assets, but it is also one of the most difficult to protect, especially during uncertain economic times. Following these guidelines will help protect your institution from unnecessary reputational risk.

Where to Find Information on FDIC Insurance Coverage

A few weeks ago, $307 billion Washington Mutual Bank (WaMu) was closed by the OTS, and the FDIC was named receiver. JP Morgan Chase subsequently acquired WaMu in a transaction that was facilitated by the FDIC and came at no cost to depositors.

The OTS blamed a lack of liquidity for WaMu's failure, as customers systemically withdrew more than $16 billion of deposits in the nine days preceding its closure. "What we need to do is understand what got WaMu into trouble in the first place," OTS Chief Operating Officer Scott Polakoff told CNBC in an interview.1 Mr. Polakoff elaborated that the OTS may have fallen short in educating consumers about the FDIC. "It's critical that depositors understand FDIC insurance and be comforted by the FDIC insurance," he said.

Information for bankers and depositors on FDIC insurance coverage on deposits can be found on the FDIC's website Exterior Link. Recently, legislation was passed to raise basic FDIC insurance from $100,000 to $250,000 per depositor.2 A depositor can have more than $250,000 at one bank and still be fully insured, provided the accounts meet certain requirements. MyFDICinsurance.gov provides guidance about how these limits work.

The FDIC also encourages bank deposit customers to use EDIE the Estimator, an online tool available on the FDIC website Exterior Link, which provides customized information about insured accounts. Customers without online access may call 1-877-ASK-FDIC toll-free for further assistance.

  • 1   Zawacki, Tim, "OTS in Damage-Control Mode on WaMu Failure," MarketWeek, SNL Financial, LLC, September 26, 2008.
  • 2   On October 3, 2008, President Bush signed the Emergency Economic Stabilization Act of 2008, which temporarily raises the basic limit on insurance coverage from $100,000 to $250,000. The legislation provides that the basic deposit insurance limit will return to $100,000 after December 31, 2009. For an overview of deposit insurance coverage reflecting the temporary increase, please go to the FDIC website Exterior Link.
  • 1   Petruno, Tom, "Sen. Reid's Loose Lips Sink Insurance Stocks," Los Angeles Times Exterior Link, October 3, 2008.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.