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Reputational Risk: A Growing Concern

In this post credit crunch era of modern banking, regulators continue to struggle to determine the most effective penalty for banking institutions found guilty of malfeasance. Historically, the most popular form of punishment has been to levy a fine. For many financial institutions though, regulatory fines have simply become a cost of doing business. This issue has lead regulators to wonder if there might be a more effective penalty that would serve as a better deterrent.

It’s no surprise that regulatory fines are frequently the first line of defense, so to speak, when it comes to banking regulation. The idea of an eye for an eye is fundamentally as old as humanity, and there is some psychological sense in the logic of attempting to make the victim of the crime feel somewhat whole. In fact for many smaller, regional banks a regulatory fine might be the most suitable course of action. Retail banks are generally built on a basis of a personalized trust. The clients of the bank want to feel that the bankers are working in their best interest, and indeed that personalized trust is frequently the reason that the client has chosen that institution over a larger, international institution in the first place.

However, the fines alone are still quite frequently not enough. It is the resulting public relations repercussions that usually have the most impact on the bank and its reputation. In fact, following the credit crunch, some of the smaller mortgage lenders were never able to recover from the loss of business and ended up drastically cutting operations or shuttering their businesses completely. It is the resulting reputational risk that is the true regulation that keeps most companies on the straight and narrow.

For larger multinational corporations, the issue can be a bit more complicated. Generally speaking, these companies can afford to maintain larger legal, PR and marketing departments in order to fight the reputational risk.

Furthermore, a million dollar fine could feel like a mere drop in the bucket for a firm with billions of dollars in assets under management. Certainly with such a small amount of skin in the game and a large war chest to fight the battle, a fine alone may not be enough to corral larger institutions.

In the recent case of a French banking giant some outside the box thinking has taken the form of a ban on dollar clearing. The bank has recently pleaded guilty to charges of hiding transactions from blacklisted nations. Since this is not a first time US banking sanctions offense for them, regulators decided to institute a one year ban on certain dollar clearing transactions. The regulatory action could have a ripple down effect for clients of the bank and potentially impact the revenue stream of the bank directly by essentially making it impossible for some domestic and international clients to continue doing business with the bank.

This case has garnered a lot of attention from the financial world and beyond. Banking officials and regulators have been watching the case closely and will likely continue to do so as the year progresses. If nothing else, this landmark case will go a long way in showing that regulatory fines alone may not be enough anymore. Going forward, the fines will need to be backed by regulatory imposed changes, market order limitations and more stringent penalties in order to be effective.

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