September 29, 2006
What is the hardest risk to model?
Recently I was asked this question at a conference and after some thought I would have to say that reputation damage in the operational risk camp would be the most difficult to understand, not just because of the varied potential drivers that seem to cause it but also because there seems to be total random and unpredictable outcome(s) from the mix of these nebulous triggers and catalysts.
Basel II – Pillar II, Paragraph 742:
Other risks: Although the Committee recognizes that ‘other’ risks, such as reputation and strategic risk, are not easily measurable, it expects industry to further develop techniques for managing all aspects of these risks.
So In Basel II, it has been flung into the Pillar II bucket and on occasion one does tend to feel that Pillar II is the dumping ground for the un-solvable, to hard basket. But while it is out sight it isn’t gone of good. Then I suppose one does also feel a little reserved to stand on any kind of ‘soap box’ with a panacea bright spark solvent, not that I have discovered such a workable structure for Reputation Risk as yet nor have I seen any bank with one.
An obvious move would be to use scenario analysis to fasten potential reputation damages against an event and in that way we are able to at least tie an event to reputation or more importantly reputation to an event. Then one does ponder if every event could have reputational outcome or components? Some banks have leapt on this idea and their risk systems have been modified to include additional investigative pages during loss reporting that allow staff to estimate the potential brand damage from an incident. I have also heard many risk practitioners state reputation damage is actually the poor management of a crisis and in that respect each operational loss could be seen as a potential driver for reputation risk.
If one thinks of their own experience on the other hand, it seems to be the companies that frustrate me most are the ones that insult our own internal and personal moral being and in that respect, reputation damage would be tied to the inability of a company to deliver targets as sold, to meet perhaps a minimum industry standard or to build an image that is compatible with the disposition of its clients. If we look at reputation damage in this light, it is now a very difficult and different task because no customer demographic is the same and every bank wants to be able to cross sell to as many communities as possible even if these communities are incompatible with each other.
If reputation risk wasn’t so impacting a sane risk manager would put it at the end of the to do list and it would become the hasta mañana of all risk event classifications. There is however, so many evidential news articles of companies both in and out of the banking sector that are alike with total failure from this disorder; so we can't right it off as a ludicrous exercise.
In an old article from the British Bankers Association
Reputation Risk a secondary risk to which capital is not the answer. Proper systems and controls, through senior management approval of, for instance new products, ensure that a bank's intangible reputation capital is not eroded.
I am not quite sure what reputation capital is but I assume it is the capital that is at risk from reputation damage, whether that includes lost opportunities or not is undefined.
There are currently no robust methods to quantify the amount of extra capital required if any - to address issues such as reputation risk and residual risk.
Some years back at a customer satisfaction forum I attended one participant stated to the auditorium, “brand damage was the continual erosion of moments in time.” That is many customers are resilient to a single fault but it is the general lack of quality or the disappointment of working with an organisation through “mini-inadequacies” that perturb customers from furnishing a business with their custom. Such clients are more likely to close their accounts if a branch’s climate was too cold or hot AND difficult to locate AND slow due to long queues AND aesthetically unpleasing to the eye OR even if it in some way did not satisfy their socio-political beliefs. So in this way there are a lot of conditions and variables that need to be weighted and accumulated before failure occurs. Some logical gates that could be grouped together and mapped out in a causal network of NOTs/ORs/ANDs for definition and then calculated using a Bayesian or Boolean~Binomial algorithm.
On the subject of Socio-political beliefs however, we have all experienced this first hand and customs that are accepted as polite in some cultures can be obtuse to others. The mere fact though that we are debating these subjective intangible qualities does lead me to believe that the operational risk team may not be the most sensible place to house this exposure and perhaps the marketing department should be taking the lead particularly as the quantification tools available to banks for reputation damage seem to me as crude and sparse.
Comments are certainly welcome from anyone and everyone specifically if they have a heads up on a neat tool or methodology to measure this creature.
Posted by CausalEvents at 03:42 AM
| Comments (0)
