Reputation risk

Reputation risk (or reputational risk) (RR) is the risk of negatively affecting the company's / group's image, which could prejudice its ability to retain and generate business. It will be evident that RR is closely related to HRR.

RR is a risk faced by all companies, but is particularly crucial in the case of banks. Continuation of business depends on reputation, and any damage to reputation can exacerbate liquidity risk. Bank runs have been caused by damage to reputation.

Management of RR amounts to:

• Ensuring that HRR management is sound.

• Having a vigorous internal communications policy. RR issues are usually generated internally (and affect the motivation of staff), and spread externally. Internally a robust whistle-blower-confidentiality policy should be in place.

• Having a vigorous external communications policy. If a negative reputational issue is externalized, predetermined communication channels should be in place so that the damage can be minimized. Predetermined communication channels are also used to maximise the outcome on reputation of good information.

Compliance risk

Compliance risk (CR) is the risk of non-compliance with:

• Statutory requirements of the various levels of government

• Regulatory requirements of regulators, in this case the banking regulator.

• Regulatory requirements of other regulators that may be applicable (because the central bank usually regulates banks only).

• Regulatory requirements of the financial exchange/s.

• Other generally accepted codes, such as the corporate governance codes.

Non-compliance may lead to the withdrawal of licenses to do business, and to the incurring of penalties. This has severe RR fallout.

Management of CR amounts to:

• Having in place a comprehensive compliance-reporting framework.

• Ensuring that CR reporting is part of the internal and external audit processes.

• Ensuring that CR reporting is on the agenda of the Audit Committee of the board of directors.

Legal and documentation risk

Legal and documentation risk is the risk of some unanticipated legal or documental hindrance that renders transactions incomplete or non-binding.

The management of legal and documentation risk involves the consulting of expert legal advisers, consulting with the revenue and other authorities when appropriate, and the avoidance of transactions where there remains doubt about the legality of the transaction.

External risk

External risk is the risk that parties other than the bank itself (and its employees) undertake activities, or fail to deliver essential outsourced services, that harm the bank in a financial or other sense, and natural disasters that affect the services or viability of the business. Examples are:

• A fire at the only chequebook printer in the country which puts it out of business for a long period.

• A devastating fire at the company that has backed-up the electronic files of a bank whose systems have failed.

• A power-delivery blackout for three days.

• An earthquake that substantially damages the premises of the head office.

• Bank robberies.

Managing external risk involves identifying the potential external risks, and managing them accordingly. For example, the possibility of an earthquake is managed by having all the required back-up systems in another city. Robberies are managed by implementing appropriate security measures. A possible electrical blackout for three days is managed by installing back-up generators.

In conclusion, it needs to be mentioned that some scholars include solvency risk in the list of risks. It is the risk of the bank being declared insolvent, a profound condition where the capital and reserves of the bank are at or near to zero, or negative, and this is an acute outcome of the reckless management of the bank in terms of risk-taking. In our view it is not a separate risk, but the outcome of mismanagement of one or more of the other risks.

Bibliography

ABSA Bank Limited, 1992. Banks. In Falkena, HB, et al (editors), Financial institutions. Halfway House: Southern Book Publishers.

BBC, 2003. Nick Leeson and the fall of the house of Barings (video).

Bessis, W, 1999. Risk management in banking. New York: John Wiley and sons.

Heffernan, S, 2000. Modern banking in theory and practice. New York: John Wiley and sons.

Grameen Bank [Online]. Available: grameenbank.org. [Accessed various dates].

Institute of Bankers in South Africa, 2002. [Online]. Available: iob.co.za. [Accessed June 2000].

McInish, TH. 2000. Capital markets: A Global Perspective. Blackwell Publishers Inc., Oxford.

Mishkin, FS and Eakins, SG, 2000. Financial markets and institutions. Reading, Massachusetts: Addison Wesley Longman, Inc.

Office of the Banking Adjudicator, 2002. [Online]. Available: oba.org.za. [Accessed June 2002]. Pilbeam, K. 1998. Finance and financial markets. London: Macmillan Press Limited. Public Investment Commissioners, 2003. Annual Report.

Reilly, FK and Brown, KC. 2003. Investment analysis and portfolio management. Mason, Ohio: Thomson South Western.

Rose, PS, 2000. Money and capital markets (international edition). New York: McGraw-Hill Higher Education.

Saunders, A, and Cornett, MM, 2001. Financial markets and institutions (international edition). New York: McGraw-Hill Higher Education.

Santomero, AM and Babbel, DF, 2001. Financial markets, instruments and institutions (second edition). Boston: McGraw-Hill/Irwin.

The Standard Bank of South Africa Limited. The assistance of Mr Glen Jackson, Director, Retail Banking, KwaZulu-Natal, with some of the retail banking terminology, is gratefully acknowledged.

The Standard Bank of South Africa Limited, 2004. [Online]. standardbank.co.za/. [Accessed various dates].

South African Reserve Bank, 2001. Annual report of the Bank Supervision Department. Statutes of the Republic of South Africa, 1989. South African Reserve Bank Act, 90. Statutes of the Republic of South Africa, 1990. Banks Act, 94.

Statutes of the Republic of South Africa, 2000. Regulations relating to banks. Issued in terms of the Banks Act 94 of 1990, Government Notice R.1112, Government Gazette No. 21726, 8 November.

World Bank, 2005. Deposit insurance around the world: a comprehensive database. World Bank Policy Research Working Paper 3628, Washington D.C.: World Bank. [Online]. Available at: econ.worldbank.org, [Accessed December 2005].