Reputational Risk for financial institutions: a proposal of quantitative approach

The reputation of an institution refers to its public image in terms of competence, integrity and trustworthiness, which results from the awareness of its stakeholders. The related risk, i.e. “Reputational Risk”, is defined as the current or prospective risk of a decline in profits or capital resulting from a negative perception of the financial institution image by clients, counterparties, shareholders, investors or supervisory authorities. In this scenario, the reputation and the assessment of the associated risk component represent a decisive factor for ensuring long-lasting profitability. In recent years, the importance of managing and monitoring Reputational Risk is growing in importance with supervisory authorities, but nevertheless, there are no specific guidelines yet that the institutions can follow. The lack of a precise orientation means that the risk component is still considered discretionary, subjective and highly prone to interpretation. Considering that in the economic literature there is not a universally accepted approach, the aim of the paper is to provide a quantitative and objective methodology, a Quantitative Model, to assess the Reputational Risk in order to overcome the limits of a qualitative approach, by using exclusively numerical and objective analysis drivers, and to meet the increasing attention of the supervisory authorities on the issue. The Quantitative Model structure allows firms to study and to monitor the phenomenon from a managerial point of view. This approach provides financial institutions, in particular the Risk Management Department, a model to evaluate the reputational risk arising from economic magnitudes that characterise the business model of the financial institution. This means that the quantitative Model enables financial institutions to steering possible negative situations and promptly intervening with any corrective measures or actions deemed appropriate.