Regulatory Penalties and Reputational Risk: Evidence from Systematically Important Financial Institutions

Since the financial crisis in 2007, banks have been hit by legal settlements from incidents related to the crisis. Over time, the frequency and the magnitude of these fines has only increased, thereby, implicating that... [ view full abstract ]

Since the financial crisis in 2007, banks have been hit by legal settlements from incidents related to the crisis. Over time, the frequency and the magnitude of these fines has only increased, thereby, implicating that financial misconduct is not an idiosyncratic risk that can be ‘spot treated’ with just fines and sanctions. By examining the stock market reactions to the announcement of fines on systemically important financial institutions (SIFIs), this paper attempts to examine whether the announcement of a fine has any impact on the bank’s reputation. We use a hand-collected dataset comprising of fines imposed on SIFIs over 13 years by regulators across the US and the UK and implement a standard event study methodology. Results show significant, negative abnormal returns at the announcement of an investigation. Fines related to investment banking are significant and negative as well as those associated with related parties, but not third parties