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Scandals have tarnished the reputation of banks to the point where some experts are calling their viability into question.
Caroline McDonald, CFO Magazine
September 1, 2012
Beset by scandals and debacles, from the peddling of subprime securities to money laundering, rogue trading, robo-signing, LIBOR fixing, and more, the banking industry has squandered much of its reputational capital in recent years. Indeed, banks' very survival may depend on regaining their customers' trust, some experts contend.
"Other industries, such as grocers, are recognizing the trust issues and are moving into the banking sector," says Steve Culp, a managing director at Accenture Risk Management based in London, noting this trend in the United Kingdom. "They are getting licenses and leveraging their brand to attract customers."
On top of this, banking profits are not what they once were. "Our analysis of the industry says that from 2000 to 2008, the profitability levels were 25% to 26%," Culp notes. Today, profits "have dropped significantly," he says. "Institutions are now chasing a 12% to 14% target." As a result, banks cannot afford "customer churn" the way they could formerly, says Culp. "From what I can see, the industry understands [that]," he says. "This will be the key area banks need to win if they're going to remain profitable and survive."
The buildup of corporate cash poses yet another threat to banks with wounded reputations, says Bruce Lynn, managing partner with the Financial Executives Consulting Group. "Banks run the risk that companies flush with cash may use their own funds for purchases such as mergers and acquisitions," he says. Companies will be deciding whether to make a purchase with 90% debt or with 50% debt "and make up the difference because they have the cash on the balance sheet."
The net effect of badly managed reputational risk, says Lynn, is that "people don't want to do business with you."
The Next Shoe to Drop?
Fines and nonprosecution agreements haven't changed the behavior of the financial industry, says Lynn. UBS, for example, has "sworn several times over the last few years they'll never do it again." (In 2009, UBS paid a $780 million fine and signed a deferred prosecution agreement in connection with its sale of offshore private-banking services to U.S. clients. Last fall, UBS CEO Oswald Gruebel resigned in the wake of a $2.3 billion scandal involving unauthorized trades. Currently, the bank is one of a dozen being investigated for manipulating LIBOR.)
"Where the next shoe could drop is if a bank is convicted of a crime," says Lynn. "Some of its customers will not want to do business [with it]. Why would you want to do business with a known criminal?" There could be some criminal indictments, says Lynn, "and criminal indictments are very serious to a bank." Banks will "do anything to avoid them, because they will no longer be able to play and the corporates will go somewhere else."
"This is why up until this point the Justice Department didn't want to convict a bank of a crime," Lynn adds. "It creates a problem for a publicly traded corporation to be known as doing business with somebody convicted of a crime."
Criminal charges or not, one outcome of the LIBOR scandal is certain, says Lynn: "Tens of millions in fines and legal fees and a huge settlement." Everyone from shareholders to companies that banks do business with will file lawsuits — and lawsuits mean damaged reputations.
In order for banks to build up trust again, they will have to focus on communication and consistency, says Culp.
Banks need to communicate externally that they are proactive lenders in a difficult economic time, he says. Internally, they need to communicate what kind of behavior is rewarded and the business strategy of the institution.
"That leads to consistency," says Culp. "Because your communications say you want to drive sustainable profitability, you don't want to reward reckless behavior. Yet your compensation or reward structures [may not be] in alignment with that." If the bank is inconsistent in this area, he says, its employees' behavior will align with how they're measured and how they're rewarded.