Northern Rock is not the first financial crisis to prompt headlines talking of damage to reputation

Northern Rock is not the first financial crisis to prompt headlines talking of damage to reputation. How many people really know what makes a reputation and what a damaged one looks like? Here are five facts about reputation damage worth remembering -

1. Reputation is not something you own but is attributed to you by others. You can’t control it directly but can influence it through your behaviour.

2. Reputation can be good or bad. You can earn a good reputation or deserve a bad one. It is far easier to turn a reputation from good to bad than vice versa.

3. A good reputation is a valuable endorsement of trust. We trust bishops, headmasters and bankers, more than we do estate agents, car salesmen or politicians.

4. There is a fairly close correlation between ethical behaviour and a good reputation. This is because trust requires a mutual understanding between right and wrong.

5. The better the reputation the more vulnerable it is and the more susceptible to damage. The principle of ‘The higher you are the further you fall’.

Damage to a good reputation occurs when our trust is shown to have been misplaced. You expect your money safe in a bank, and children safe with a teacher. So when people talk of damaged reputation they actually mean that they made a mistake and placed trust in someone (or something or somewhere) that ultimately wasn’t justified. They are cross about their own error of judgement and thus confidence is lost. This is why errant bishops, teachers and bankers make headlines. It is because our expectations of them are comparatively higher than other mortals, in whom we don’t place as much trust.

Reputation is a perception of character and while we expect a bank to be a safe haven for our money we also trust the banking regulator and central bank (as lender of the last resort) to play their respective roles in the complex financial system that protects our money. In the Northern Rock crisis gaps have appeared between the roles of regulator and Bank of England that have damaged their respective reputations as much as Northern Rock.

The FSA as regulator considers its role as policing good and bad practice. It does not see its role as determining acceptable high and low risk in business models. Where high risk becomes bad practice is a very indistinct line. Once the inter-bank lending rate rose to cut off money supply warning bells rang but the regulator was aware of the business model of banks like Northern Rock and did not see liquidity risk as a strategic risk. Is this a rather blinkered view of risk? Independent risk analysts had identified vulnerability in the Northern Rock business model long ago.

The Bank of England, by contrast had decided that the inter-bank credit freeze was a market adjustment so would not intervene. Unlike other lenders of last resort around the globe who saw it as their duty to step in and prop up a banking system under pressure. Admirable although this was for a while it meant that someone would suffer. Once the governor of the bank of England specified who this might be, the crisis erupted and it required political intervention to head of a crisis of consumer confidence cascading down the high street. The Bank of England has now agreed to pump £40bn into the banking system to support it.

The government initially supported the prudent stance of the central bank as it mirrored the sentiments of the prime minister. However this changed within 24 hours once the run on one bank looked likes spreading to several others, and the government stepped in to guarantee savings at Northern Rock. Confidence returned to savers but shareholders were left with a massive bill. The government’s reputation was not enhanced by this u-turn.

Reputation damage is rarely isolated and contamination is common. The reputation of one high street bank as a safe haven for savings has been shattered. The reputation of the regulator as an arbiter of good practice is severely damaged and the reputation of the Bank of England for discrete support of industry has been destroyed by the governor’s unprecedented decision to name and shame one bank ‘pour encourager les autres’ . The government hasn’t come out of it very well either, given the way the chancellor changed his strategy in one day and likely put pressure on the Bank of England to inject funds to the banking system contrary to its preferred stance.

What could have been done to protect reputations? Either the regulator should have acted sooner or the Bank of England should have taken a more discrete line. Different approaches to liquidity risk sparked an erosion of consumer confidence. This in turn destroyed shareholder value overnight, requiring hasty government intervention. There is no doubt that the treasury, Bank of England and regulator need to look at how the co-ordinate policy and communicate it both to the industry and general public. This will be seen abroad as wholly home-grown cock-up.

Trust in the UK banking system has been questioned and the reputation of key players involved in the governance of the system has been damaged. As with all reputation damage recovery depends on three things: how strong your reputation was before the incident, the nature of and cause of the damaging incident and ultimately how you respond to the incident. It is too early to say who the victims will be as the fallout from the crisis continues.

Garry Honey is the author of ‘Corporate Reputation – perspectives on measuring and managing a principal risk’ published by CIMA, and the founder of Chiron