Perspective: Needed, A Holistic Approach to Reputation Risk Management in Banks

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www.infosys.com/finacle …

www.infosys.com/finacle

Technology is the key enabler of risk management. An enterprise-wide risk management solution brings down silos to facilitate integrated risk management and a holistic view of organizational risks.

www.infosys.com/finacle

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  • 1. Needed, A Holistic Approach to ReputationRisk Management in Banks Universal Banking Solution System Integration Consulting Business Process Outsourcing
  • 2. In 2011, when American citizens were still reputation, which as mentioned before, is at riskfeeling the ill effects of the financial crisis, a from all other risks. Effective risk managementwell-known U.S. bank decided to impose a calls for replacing the current silo frameworkUS$5 monthly fee on debit card usage, impervious with a holistic approach, with Customer Trustto the prevailing customer sentiment. This and Employee Belief as the supporting columns,seemingly innocuous decision sparked serious as depicted in Fig. 2.outrage to fuel the Bank Transfer Day protestswherein people shifted in droves from “big bad Management of Risk Islands in Banksbanks” to customer-friendly credit unions. Credit Market OperationsReputation or goodwill, that invaluable asset of Risk Dept. Risk Dept.the banking industry, is also probably its mostfragile one. Reputation risk or the risk of loss of Audit Business Branches Treasury Risk Dept. Unitsreputation is also called “risk of risks”, as it oftencomes on the heels of other risks in banking, Operational Liquidity Legalbut differs from them in that it is intangible and Risk Dept. Risk Dept. Risk Dept.hard to measure. Compliance Reputation & Control Risk IT &Indeed, even defining reputation risk can be a Risk Dept. Dept. Infrastructurechallenge, according to Dr. Jean Paul Louisot,who said that, “There’s no such thing asreputation risk… rather all risks may have animpact on an organisation’s reputation.” But its CORRELATION OF RISKS IN BANKSimpact is felt in no uncertain terms as negativepublicity, litigation, loss of revenue, clients,partners and key employees, decline in share Market Liquidity CONFIDENCE Risk Riskprice, and difficulty in recruiting talent. TRUST ReputationUnfortunately, most banks view the risk of Operational Risk Risk Credit Riskreputation loss as a standalone problem, failingto recognize that all other risks, namely credit, Sovereign Legal Riskmarket, operational, liquidity etc., feed into it. For Riskinstance, the operational risk of data theft byemployees, the credit risk associated with heavylending exposure to a single industry, the Origination of Reputation Risks in the Bankingmarket risk inherent in instruments like credit Processswaps or stocks, can all snowball to hit banks’hard-built reputation. In the context of day-to-day banking, the threat of reputation loss lurks under the surface atNeed to Look Beyond Silos every stage, whether it is customer prospecting, onboarding or transaction processing.It is not reputation risk alone that is managedin silos. Fig. 1 illustrates how banks typically Prospectingdeal with each risk individually. The problemwith having islands of risk is that the banks Banks put their reputation on the line evendo not know the size of the (risk) problem. as they approach customers during theMoreover, individual risk management teams prospecting stage. Often, sales executives coldact to mitigate only a single type of threat, taking call prospective customers who currently haveno cognizance of the impact of their actions on no need for the bank’s products. Such calls,other types of risk. especially when repeated, annoy customers and might even alienate them forever. WhoClearly, such a disparate risk facing mechanism hasn’t been harassed by telemarketing executivesis not best equipped to guard the banks’ selling loans? Needed, A Holistic Approach to Reputation Risk Management in Banks
  • 3. In their desperate attempts to sell, banks often the customer.onboard customers with doubtful antecedents,who go on to engage in fraudulent activities While the best policy is to anticipate and avoidand ruin their banks’ reputation. This is frequently such situations, the next best thing is to react asseen in the case of credit cards, personal loans etc. quickly as possible to arrest the damage.Customer Conversion Customer Communication It is relevant to discuss one of the softerCentral Bank guidelines mandate banks in most aspects of customer retention, namely, customercountries to run their new customers through communication, in the context of reputationKnow Your Customer (KYC) checks. However, risk. Banks are often (maybe inadvertently)this has its limitations as the checking is insensitive and inappropriate in theirrestricted to address and income verification, communication, causing irreparable harm tocredit history and risk classification. Banks need their reputation and brand. Take the instanceto look beyond mere KYC compliance and of a sales representative who mistakenly triesstrengthen their reputation risk management to sell a credit card to a customer who alreadymechanism with KYCB (Know Your Customers’ has one and is struggling to keep up with hisBusiness) and KYBR (Know Your Customers’ payments. Far from adding value, such anBusiness Risk) processes. action will create a negative impression. BanksThe following examples show how KYCB and therefore need to understand the demographic,KYBR processes are central to detecting psychographic and other characteristics of theirreputation risk: When a bank signs up a bullion customers and tailor their message accordingly.trader as a customer, it anticipates large and Technology can play a big role in this.frequently occurring transactions. While frequent,high value transactions are typical of legitimate 5C Dimension in Mitigating Reputation Riskbullion trading, their pattern is very similar to Just as reputation risk can arise from variousmoney laundering transactions. Unless the bank quarters, ranging from regulatory non-compliance,closely investigates the customer’s business sub-standard service or irrelevant or poorcredentials, it will never be able to detect if the quality communication, inadequate securitytransactions – which look genuine – are actually a infrastructure and shortfall in financial performancefront for illegal activity. to poor crisis management, association with partners of poor repute, lip service to CorporateIn-depth customer (and customer business) Social Responsibility and labor unrest, it canunderstanding will facilitate awareness of also leave a multi-dimensional impact on theinterrelated risks between different groups of organization and its 5 Cs, namely, the consumer,stakeholders like customers, investors and capital, compliance, cost and competition.guarantors, and highlight the possibility of a Conversely, managed well, these elements cancascading effect were one of these relationship also bolster a bank’s reputation.nodes to come under pressure. Such investigationassumes great significance especially in trust- Consumerbased transactions. For service organizations like banks, which areBusiness as Usual built on trust and confidence, instilling these is a surefire way of managing reputation risk.Banks must also proactively manage the risk of Banks can build customer confidence with efficientreputation loss in the course of operations. Say service, flexible and customized products andthat on account of an ATM malfunction, a cash technologically advanced banking channels.withdrawal is not processed but the customer’saccount is nonetheless debited. In this online Capitalreal-time world, reports of such an occurrencecan be tweeted in seconds. This gives the When their risk goes up as a result of operationalopportunity to a rival bank, which is listening in silos or because the mitigating factors are noton social media, to swoop in and take away identified properly, banks will have to maintain Needed, A Holistic Approach to Reputation Risk Management in Banks
  • 4. higher regulatory/ economic capital to avoid Look Beyond Bankingbankruptcy and liquidity crunch. Conversely, bylowering operational risk, they can free up Traditionally, banks have looked up to thecapital and consequently, reduce the level of reputation risk management standards set byreputation risk. other institutions within the industry. It is high time they moved their focus beyondCompliance banking and looked at the innovative ways in which businesses like consumer products orBy establishing comprehensive risk identification automobiles – where a large number of customersand classification processes, in accordance with and counter-parties are involved in the supplycompliance requirements, banks can guard chain and product liability is high – manageagainst compliance failure and its negative their reputation.consequences. Infuse Belief in EmployeesCost First, the workforce – from the seller to the tellerThe knowledge that their work significantly to the Chief Risk Officer and the Board – mustimpacts the organization as a whole motivates be convinced that its talent have a significantemployees to put their best foot forward. bearing on the organization’s fortunes, and canEmployees must also be sensitized to the make or mar the bank’s reputation. Next,different risks inherent in their daily tasks, employees must be trained to distinguishand trained in ways to avoid them. Of course, between risky and risk-friendly behavior so thatthis comes at a cost, as banks have to spend they are confident about their actions.considerable sums of money for periodictraining of core staff and building up case Ensure Employee Satisfactionstudy repositories for future reference. But it ismoney well spent. Banks should realize that employee satisfaction also impacts reputation. Contented employeesCompetition will perform their jobs to the best of their ability, which will manifest as better service, higherBy losing their reputation, banks play right into quality and an employee-friendly workplace. Asthe hands of competitors who will seize the good employers, banks will attract the bestopportunity to cause further damage. On the talent, who will further enhance their quality ofother hand, a strong image or brand is not only service and image.the best source of competitive differentiation, butalso an intangible asset on the Balance Sheet. Create Knowledge BanksA Broader Approach to Reputation Risk Today, banks do not have access to knowledgeManagement repositories of case studies on how organizations within and outside the industry have managedMost banking organizations view risk mitigation reputation risk in the past. They must build suchas a compliance issue, and the domain of information storehouses in order to learn fromthe risk management team. Business rarely others’ mistakes and also their best practices.gives a thought to how its actions can adverselyimpact the bank’s risk profile. On their part, Deploy Enterprise-wide Solutionsrisk managers practice their craft in an insularmanner, rarely looking beyond the tried and Technology is a key enabler of risk management.tested, the banking industry and the regulator’s An enterprise-wide risk management solutionrule book. They might benefit from the brings down silos to facilitate integrated riskfollowing ideas: management and a holistic view of organizational Needed, A Holistic Approach to Reputation Risk Management in Banks
  • 5. risks. This permits a deeper understanding of medium in order to keep tabs on publiccustomers and their risks and allows banks to perception and improve customer engagement,take precautionary measures well in advance. banks have chosen to stay away. They need to come to terms with this reality, because asUse Analytics as a Tool someone famously said “the only way to put out a social media fire is with social media water.”A hitherto unexplored area in risk management Failing that, all their efforts to build reputationis analytics. While this tool is extensively used will come to naught in social networks.in sales and marketing, banks are yet torecognize its potential for managing reputation Proactive Management is the Keyrisk. Banks have access to massive amounts ofinformation, or big data, which can be fed into “A key challenge in measuring reputation risk is toan analytics solution to generate valuable risk first define what it is…”insights. Technology vendors have their taskcut out, namely to encourage banks to utilize the As mentioned earlier, prevention is the bestpower of analytics in this area. way to manage reputation risk. Banks need to strengthen their early warning system byLog on to Social Media monitoring reputation consistently and regularly, anticipating the financial impact of reputation riskToday, reputations are not built within and proactively managing high risk situations.organizations, but rather in the online world ofsocial media, where a single negative commentcan spread like wildfire within hours across Authorthe globe. So far, banks have largely been at the Manish Jainreceiving end of social media ire, no doubt, in Industry Principalreturn for the events of the past four years. InfosysUnfortunately, rather than participating in the Needed, A Holistic Approach to Reputation Risk Management in Banks