Operational and reputational risk in the European banking industry: The market reaction to operational risk events

Topics: Stock market, Operational risk, Risk management Pages: 88 (9937 words) Published: September 30, 2013
Journal of Economic Behavior & Organization 85 (2013) 191–206

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Journal of Economic Behavior & Organization
journal homepage: www.elsevier.com/locate/jebo

Operational and reputational risk in the European banking industry: The market reaction to operational risk eventsଝ
Philipp Sturm ∗
Department of Banking, University of Tübingen, Mohlstraße 36, 72074 Tübingen, Germany

a r t i c l e

i n f o

Article history:
Received 19 August 2011
Received in revised form 17 February 2012
Accepted 13 April 2012
Available online 21 April 2012
JEL classification:
G14
G21
Keywords:
Banks
Event study
Operational risk
Reputational risk

a b s t r a c t
In this paper I study the stock market reaction to the announcement of operational losses in European financial companies. Accounting for the effect of the nominal loss amount allows for an examination of the reputational damage caused by operational loss events. The analysis is based on a sample of 136 operational losses stemming from a database of the Association of German Public Sector Banks (Bundesverband öffentlicher Banken, VÖB). All operational loss events affect European financial institutions with settlements reported by the press between January 2000 and December 2009. In line with previous literature, I find a significant negative stock price reaction to the first press announcement of operational losses. Results show that the stock market also reacts negatively to the settlement announcement as losses are confirmed and the loss amount is known. Even after accounting for the nominal loss amount, cumulative abnormal returns are negative following the date of the initial news article and the settlement date indicating damages to the reputation of the firm suffering the operational loss. Multivariate regression results suggest that reputational damages are rather influenced by firm characteristics than characteristics of the operational loss event: companies with a high ratio of liabilities to total assets suffer more severe damages to reputation from operational losses than companies with more equity. © 2012 Elsevier B.V. All rights reserved.

1. Introduction
While operational risk has been receiving significant attention by regulators for more than a decade, incidents such as the exceptional loss at Société Générale of almost five billion Euro in 2008 caused by the trader Jérôme Kerviel once more spurred the interest paid to operational risk by regulators, supervisors, bank executives, and the public. Other prominent examples of operational risk events include the failure of Barings bank in 1995, the 850 million Euro loss due to unauthorized trading at AIB in 2002, the unimaginable Ponzi scheme of Bernard Madoff discovered in 2008 and, most recently, the loss of UBS caused by rogue trading exceeding 1.5 billion Euro in September 2011. Even though these events led to an increased awareness of operational risk and its importance, operational losses keep surfacing and the times of financial crises reveal new deficits of the operational risk management practices in place. The reliance on information technology and automation as well as the increasing complexity of new products in financial services firms are changing their exposure to operational risk. Automation, for example, can help to reduce the likelihood of minor errors in manual processing, but it increases the

ଝ I would like to thank Werner Neus for his ongoing support and helpful comments. The paper has also benefited from the comments of two anonymous referees, Kartik Anand, Sven Bornemann, Felix Noth, Frederik Hesse, participants of the Conference on Financial Sector Performance & Risk 2011 in Bangor, the VHB Annual Congress 2011 in Kaiserslautern, the International Risk Management Conference 2011 in Amsterdam, the XI. GEABA conference 2010 in Frankfurt, the International PhD Seminar 2010 in Obergurgl, and the Workshop on Banking 2010 in Muenster. ∗ Tel.:...

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