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Publication Date

2020

Abstract

In the aftermath of a school shooting in Florida, the
New York State bank regulator urged banks to manage
the “reputation risk” posed by doing business with the
National Rifle Association (a gun rights advocacy
group). As part of Operation Choke Point, a federal
regulator told banks to end relationships with payday
lenders because those activities posed “reputation risk.”
Another federal regulator warns banks their reputations
might be damaged by lending to oil and gas companies
that are perceived to cause environmental harm.
Reputation risk is the risk that bank stakeholders will
negatively change their perception of the bank. It was
almost unmentioned in banking regulation until the
mid-1990s, but as these examples illustrate, it is now
ubiquitous.
This Article surveys reputation risk guidance and
enforcement efforts. It shows reputation risk regulation
is usually an ancillary consideration to credit risk,
operational risk, or other primary risk. In these
instances, reputation risk adds little because regulators
have strong tools to address the root problems.
Sometimes, however, regulators justify guidance or
enforcement primarily in terms of controlling reputation
risk. Regulators use reputation risk to weigh in on
hot-button political topics afield from bank safety and
soundness like gun rights, payday lending, and fossil
fuels. Because regulators believe reputation risk is

present in every facet of banking, little prevents them
from using it to address other controversies.
This Article argues expansive regulation of reputation
risk is harmful. There is little evidence that regulators
can accurately predict and prevent bank reputational
losses. Moreover, because reputation risk is largely
subjective, regulators can use it to further political
agendas apart from bank safety and soundness.
Unnecessary politicization of banking regulation
undermines faith in the regulatory system and
correspondingly erodes trust in banks.

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