Avoiding failures of oversight

Bank boards need data-driven, independent intelligence to flag reputational crises on the horizon.

By Nir Kossovsky and Denise Williamee

Bank failures usually incinerate their owners’ equity value. With recent failures very much in focus, there has been considerable finger pointing and speculation about culpability, but very little thought about why shareholders—through the boards of directors that serve as their agents—aren’t better protecting themselves.

It is hardly a secret that banks, while quite stable according to federal regulatory agencies and industry data, can become vulnerable to runs. Triggering a bank’s crash from hero to zero “could depend on almost anything, consistent with the apparently irrational observed behavior of people running on banks,” explained Nobel Laureates Douglas Diamond and Philip Dybvig in 1983. How is it that 40 years later, boards of directors of institutions that possess a tremendous amount of customer intelligence, in an industry that is highly regulated and highly aware of compliance and risk issues, could fail to recognize a pending conflagration and exercise more assertive governance to mitigate that risk?

Diamond and Dybvig explained that the hair trigger is a shift in depositor expectations, what we recognized today as a loss of reputational value. Did directors fail to notice that weaknesses in their banks’ reputations could cause catastrophic damage and that their depositors—which included well-known individuals and companies—could panic collectively and, with money movement easier than ever before, respond instantly?

Among the lessons we should learn about reputation risk from Silicon Valley Bank, Signature Bank, Credit Suisse and others is that directors need better, more objective information about what stakeholders expect: the source of reputation value. They need tools that help them identify early warning signs that emotionally laden disappointment may be brewing, and they need data and reference points that help them ask better questions of management and probe for answers.

When institutions become accustomed to success over a long period of time, there is a common tendency to reduce vigilance. Directors need red flags to shock them out of the lull of complacency when dormant risk threatens imminent eruption.

Dutiful directors need to be proactive—to catch what executives miss, to compensate for their misjudgments, or to question wishful thinking passing for thoughtful analysis.

Best governance practices encourage boards to improve their reputation risk oversight with independent intelligence sources on what may trigger panic-driven bank runs or stock dumps. Some directors use personal experiences to inform their opinions. We’ve heard of directors working in a customer service call center once a month or logging into Glassdoor on a regular basis to see what customers or employees are saying about the company.

But experiential and anecdotal information gathering is no substitute for rigorous monitoring. Up until recently, there have been few tools available that have proven over time to be good predictors of material reputational issues that can threaten enterprise value and stock prices. Effective tools can enable equity arbitrage strategies and the public reputation-based equity index.

Reporting platforms like this should be strong predictors of future reputation-related drops in equity values. Volatility in reputational value—a quantitative measure of stakeholders’ certainty in a company’s ability to meet their expectations—is a leading sign of the type of shifting stakeholder expectations that can trigger bank runs and stock price collapses.

These metrics showed wild swings in stakeholder expectations—signs of impending distress at Silicon Valley Bank, Credit Suisse, Signature Bank, First Republic and others—months before social media posts started runs on the bank.

At a time when banks face multiple shifting and diverse risks that are magnified and accelerated by weaponized social media, spreading like wildfire and torching reputations, reports indicating increased reputational volatility can be a powerful tool for board members overseeing the management of enterprise risks such as ESG, reputation, ethics, safety and security. Diligent boards, exercising effective governance over all that is mission critical, need independent, objective data if they are to stay ahead of the curve.

Nir Kossovsky is CEO of Steel City Re, which uses parametric reputation insurances, ESG insurances and risk management advisory services to mitigate the hazards of ESG and reputation risk. Denise Williamee is Steel City Re’s vice president of corporate services.