Regulating Bank Reputation Risk

In the aftermath of a school shooting in Florida, theNew York State bank regulator urged banks to managethe “reputation risk” posed by doing business with theNational Rifle Association (a gun rights advocacygroup). As part of Operation Choke Point, a federalregulator told banks to end relationships with paydaylenders because those activities posed “reputation risk.”Another federal regulator warns banks their reputationsmight be damaged by lending to oil and gas companiesthat are perceived to cause environmental harm.Reputation risk is the risk that bank stakeholders willnegatively change their perception of the bank. It wasalmost unmentioned in banking regulation until themid-1990s, but as these examples illustrate, it is nowubiquitous.This Article surveys reputation risk guidance andenforcement efforts. It shows reputation risk regulationis usually an ancillary consideration to credit risk,operational risk, or other primary risk.

In theseinstances, reputation risk adds little because regulatorshave strong tools to address the root problems.Sometimes, however, regulators justify guidance orenforcement primarily in terms of controlling reputationrisk. Regulators use reputation risk to weigh in onhot-button political topics afield from bank safety andsoundness like gun rights, payday lending, and fossilfuels. Because regulators believe reputation risk is present in every facet of banking, little prevents themfrom using it to address other controversies.This Article argues expansive regulation of reputationrisk is harmful. There is little evidence that regulatorscan accurately predict and prevent bank reputationallosses.

Moreover, because reputation risk is largelysubjective, regulators can use it to further politicalagendas apart from bank safety and soundness.Unnecessary politicization of banking regulationundermines faith in the regulatory system andcorrespondingly erodes trust in banks.