Reflections on Reputation and its Consequences

These reputational consequences--whether justified or not--are to be expected. Sociologists and economists have long remarked upon the central role that social trust plays in healthy markets. Market transactions depend on a whole series of assumptions that people must be able to rely on, including the soundness of money, the enforceability of contracts, the good will of their partners, the integrity of the legal system, and the common meanings of language. Social trust is the glue that holds markets and societies together. In the context of banking, social trust and reputation are related concepts. 

Banks themselves--in crisis or not--are particularly vulnerable to reputational consequences because of their public role. The principal social value of financial institutions is their ability to facilitate the efficient deployment of funds held by investors (and entities that pool these funds) to productive uses.1  This value is maximized when the cost to the entity putting capital to work is close to the price demanded by the entity that seeks a return on its investment. In traditional banking, this means that financial intermediation occurs most effectively when the interest rate charged for use of funds in lending is close to the interest rate paid for deposits. As the difference between the two grows (which would be attributable to amounts extracted by intermediaries as compensation for essential intermediation), the costs of borrowing for the purposes of creating productive projects become higher than they should be, with arguably negative reputational consequences.

Given these particular reputational dimensions associated with financial institutions, might financial regulators have an interest in considering reputational harms analytically? Could there be benefits to understanding the ways that an individual financial institution's reputation--or that of the financial industry as a whole--might have particular effects on, for example, safety and soundness, financial inclusion, or financial innovation?

1. See Sarah Bloom Raskin, Federal Reserve Board Governor (2012), "How Well is our Financial System Serving Us? Working Together to Find the High Road," speech delivered at the Graduate School of Banking at Colorado, Boulder, Colorado, July 23. See also Wallace C. Turbeville (2012), "Cracks in the Pipeline: Restoring Efficiency to Wall Street and Value to Main Street Leaving the Board," Demos, Financial Pipeline Series, December 5. Return to text