Chicago Booth Review Podcast Do You Trust Your Bank?

Rimmy Tomy: So in that local region, it does tell us that the borrowers are losing trust in the entire banking system, that it's not so much against a specific bank. And this also kind of gets more directly at trust.

Hal Weitzman: Do you trust your bank? What would it take for you to lose that trust? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman. And today, I'm talking with Chicago Booth's Rimmy Tomy about her research on trust in the financial system. It turns out that you might lose trust in your bank even if it hasn't done anything wrong. So how should banks, regulators, and customers think about the role of trust?

Rimmy Tomy, welcome to the Chicago Booth Review Podcast.

Rimmy Tomy: Thank you for having me.

Hal Weitzman: It was great to have you to talk about trust. Trust, of course, is at the heart of the financial system. The word credit means based on the idea of trust. And you say in your research that trust is fragile. It's a fragile asset. Is it an asset then? Do banks count on trust as real asset?

Rimmy Tomy: Well, so we say trust is a fragile asset because it takes a long time to build. Trust in any institution or individual takes a long time to build, but it can be quickly destroyed. So negative events can quickly destroy trust and therefore that's why it is a fragile, that's why we say it's a fragile asset.

Hal Weitzman: Okay. And you say that it's more important for retail customers than for large corporate clients. Why is that?

Rimmy Tomy: So retail borrowers are very different from large corporate clients in the sense that they have limited resources. So ex ante, before engaging with any particular bank, they are constrained. They cannot conduct due diligence the way that a large corporate client can. They don't have armies of lawyers looking into these loan contracts. So they're not able to monitor the bank.

Hal Weitzman: We've all probably been there in that situation where somebody says, "Sign this, sign this, sign this." And you really don't have any idea of what you're signing.

Rimmy Tomy: No. I mean, you might read the whole thing, but you may not understand it, right?

Hal Weitzman: You read it, right.

Rimmy Tomy: Yeah. And the fine print is not something everybody reads anyway. And so when you cannot monitor, what sort of fills that gap is trust, right? That a large corporate client has, well, all the information they need. Well, most of the information they need, they can read these contracts, they can dissect these contracts, they can ask the bank clearly exactly what they want, but a retail borrower cannot do any of those things, and so they rely more on trust. So where they don't have the information, what really fills that gap is trust.

Hal Weitzman: Right. And where does that trust come from?

Rimmy Tomy: That's a good question.

Hal Weitzman: Well, if I haven't banked with someone before, I haven't had the experience, then what is the basis of my ... Do I just ask my best friend or ...

Rimmy Tomy: You might, you might.

Hal Weitzman: How would I build trust in an institution I haven't worked with before?

Rimmy Tomy: Right. So there could be lots of different channels through which this trust builds. And the one that we specifically care about is the public signals. So these large negative events that might affect trust in a particular bank. So there could be lots of different ways in which trust is affected, including maybe speaking with your friends, the brand value of the bank, but then specifically also the news that you might hear about a particular.

Hal Weitzman: Now, I'm guessing typically when the bank at which you bank is in the news, it's typically not a good thing, right? It's usually something that's pretty negative. And you have researched some of these, what you call reputational shocks, which in the US are enforcement actions. I'm guessing from your research that there's a strong relationship between reputation and trust, right? Well, that's kind of an assumption that you're making in you're finding. So tell us about what you actually did find. What's the sort of headline finding from this study?

Rimmy Tomy: So from the US study, what we found is that borrowers tend to exit banks that receive enforcement actions and higher quality borrowers tend to exit more or rather higher quality borrowers are more likely to exit. In the India study, we find that depositors leave banks that receive large penalties. What's really interesting about both studies and where they sort of come together is that we find that depositors exit not just from the bank that received the penalty, but also from neighboring banks that did not receive penalties and therefore do not have the solvency risk that the penalty bank has. And in the US, we find that borrowers also exit neighboring banks that did not receive enforcement actions.

Hal Weitzman: So I get generally disenchanted or generally I lose trust with more than just my individual institution.

Rimmy Tomy: Yes, that is correct. That is correct. So it's more of a generalized loss of trust in the banking system.

Hal Weitzman: So let's switch to talking about in the US where you got something a little bit different going on, because you found here that higher quality borrowers are the most likely to exit a bank after it receives an enforcement action. So some people believe, and some don't. Who are higher quality borrowers?

Rimmy Tomy: So these are borrowers with higher credit scores and just a better credit history.

Hal Weitzman: Okay. Tell us what you found there.

Rimmy Tomy: So what we found is that when there is an enforcement action against a particular bank, you see an exodus of new borrowers that new borrowers are less likely to transact with a bank that received the enforcement action. And we find that its higher quality borrowers, these borrowers with higher credit scores that are just less likely to transact with the enforcement action bank.

And the reason we provide is that these higher quality borrowers, they're just more likely to have multiple banking relationships both with banks or also relationships with non-banks and therefore it's just easier for them to move. They also might have higher expectations of service quality and banks that receive enforcement actions generally tend to have poorer service quality and therefore the perception-

Hal Weitzman: And do they care more about service quality than the lower quality borrowers?

Rimmy Tomy: Yeah, we do make that argument that on the margin, yes, they would care more about service quality.

Hal Weitzman: But it's mainly that they have the option about these other institutions to put their money.

Rimmy Tomy: Exactly.

Hal Weitzman: But it's not because they're paying more attention or anything like that.

Rimmy Tomy: Well, that is a liver return. Well, we look at the media, that's one part of the analysis, but we also look at education. So we look at regions where borrowers are more highly educated and we find stronger effects there. And one reason for that, well, could be that the higher quality borrowers are more educated and therefore they might just be more aware as well. But it's harder to tease out those two mechanisms. Yeah.

Hal Weitzman: Got it. Okay. So actually you found that these higher quality borrowers often leave a sanctioned bank. And just remind us, when we talked about these reputational shocks in the US, their enforcement actions, in India, their penalties. What are the kinds of things that would earn you an enforcement action in the US or a penalty in India?

Rimmy Tomy: In the US, we looked at enforcement actions. So these are cease and desist orders, for example, and these are actions that are brought against the bank as a measure of lost resort. So when everything else fails between a supervisor and a bank, that's when the supervisor issues an enforcement action. And by everything else, I mean there might be some informal channels that the supervisor might take in order to reform the bank, but if all that fails, then the bank receives enforcement actions.

Hal Weitzman: So what are those? What are the earlier steps?

Rimmy Tomy: Well, there might be a memorandum of understanding between the regulator and the management. There could be informal enforcement actions that are generally not made public, that could also exist between the bank and the supervisor. And when the bank does not remedy those informal actions, that's when the formal enforcement action hits.

Hal Weitzman: So what are the kinds of misdemeanors that would earn you even those informal steps?

Rimmy Tomy: Yeah. So lots of different things. It could be low capital. So the bank is operating with less capital than it is. It could be high risk taking that the bank is lending much more to very risky borrowers than it should be doing. It could be expansion, too much expansion in very risky markets. It could be poor service quality, it could be instances of discrimination against certain groups. So all of those things could earn you enforcement action.

Hal Weitzman: So particularly in the first couple of ones you mentioned where they're financial measures, risk or capital, then presumably the informal action is just get that back into line. Is that right?

Rimmy Tomy: Well, not always. So we don't know, because we don't see the informal actions. What we do witness, what we can see publicly are the formal actions. So clearly, the informal actions were not able to get those things in line, which is why the regulator was then forced to issue the formal action.

Hal Weitzman: Just to give us a sense of the scale, how many enforcement actions do we have in the US?

Rimmy Tomy: It depends. It varies a lot by year. You might have a few hundred in a year versus much more than that is say after the financial crisis, there were much more enforcement actions.

Hal Weitzman: And are they mostly focused on a particular sector of the banking world?

Rimmy Tomy: They can be issued against all kinds of banks. In the data, we see that enforcement actions are mostly issued against smaller banks, not so much the larger banks. And part of it could also be that the regulator has much more scrutiny against these larger banks and the smaller ones.

Hal Weitzman: One thing you found is that these higher quality borrowers who when they leave a sanction bank, they often go to a non-bank financial institution. So what does that tell us? Does that tell us that they're losing trust in this specific bank, or are they like your Indian borrowers who are maybe losing trust in the whole sector?

Rimmy Tomy: Yeah. So it does tell us that at that regional level, because these enforcement actions that we're studying are localized, the effects we're studying are localized. So in that local region, it does tell us that the borrowers are losing trust in the entire banking system, that it's not so much against a specific bank. And this also kind of gets more directly at trust, because what this tells us there is not just a reputational effect against one particular bank, but rather it's more a trust angle, because it plays out against a whole sector. So that's what we find.

Hal Weitzman: If you're enjoying this podcast, there's another University of Chicago Podcast Network show that you should check out. It's called The Pie. Economists are always talking about the pie, how it grows and shrinks, how it's sliced, and who gets the biggest share. Join host, Tess Vigeland, as she talks with leading economists about their cutting edge research and key events of the day. Hear how the economic pie is at the heart of issues like the aftermath of a global pandemic, jobs, energy policy, and much more.

Rimmy, tell me, in the first half, we talked about your research about trust in the banking system and how people leave the banking system in general and if they lose trust in their institution. And I wanted to ask you, this is fascinating to me as an old newspaper guy, that the presence or absence of a local newspaper is important here. What role does that play in the US context?

Rimmy Tomy: Well, newspapers are important in this context, because they disseminate the information. So like I said before, the regulators disclose information about enforcement actions on their websites, but retail borrowers are not reading the regulator's website. They're not reading press releases.

Hal Weitzman: Certainly not for fun.

Rimmy Tomy: Yeah, certainly not for fun. Maybe a few do, maybe the more sophisticated borrowers are the highly educated ones.

Hal Weitzman: But it's mediated through the newspapers.

Rimmy Tomy: Exactly. So for most of the population, I mean, they're getting information through newspapers and then the local media tends to cover more local news. So if it's a small bank in a locality that's received an enforcement action for misconduct, the local media, well, first of all, reports on that incident, but then also contextualizes that incident. They can provide more information around that incident.

For example, has this bank been involved in previous types of enforcement actions? What exactly did the regulators say? What exactly did the bank manager say? They may include quotes from the community, from bank executives, from employees about what happened at the bank. And so it just provides more information to the community in order to react to this enforcement action. These news articles, they also might set the tone. For example, they might use more positive words, more negative words, convey a certain sentiment, and all of that can also influence how retail borrowers perceive the bank.

Hal Weitzman: Okay. And the media also plays a role in your India study. You looked at the 2013 Cobrapost exposé. Tell us about that. And the media, particularly how the media coverage was involved there.

Rimmy Tomy: Yeah. So the Cobrapost exposé, it happened in 2013 where the news website, Cobrapost, they send these undercover investigators to certain large banks and had them pose as customers. And basically, the managers and some employees in these banks provided techniques on how to launder money to these reporter customers. And so that was recorded. It was publicized and these are all illicit techniques. This is all against the law. And because of that, there was this huge public uproar.

And then when that happened and people got involved, the Reserve Bank of India, which is the regulator of these banks, they opened an inquiry. They sent supervisors to all of these large banks, not just the three that had been the focus of the investigation. And so they opened these investigations against all of these banks and found various difference deficiencies and because of which they imposed very large fines that were almost unprecedented.

So if you look at the history of penalties that have been imposed against Indian commercial banks in the past or ever since they've been disclosed, you don't find these large fines, so it was unprecedented. It was covered in the media quite a bit. And a lot of the media coverage was on television, because Indian news media is driven a lot by television news and there's like hundreds of channels in 22 different languages. There's at least 100 different news channels that constantly play the news on a 24-hour news cycle. And so this news was being constantly bombarded. So it's a pretty significant event, which is what we study in order to understand how depositors reacted to this video.

Hal Weitzman: You can see from the way you describe it, how easy it would be for me just to say, "I'm not putting my money in any bank." They're all kind of as bad as each other, right?

Rimmy Tomy: It could be. And also, part of it was the disclosures that the regulator made after these events were disclosed and the disclosures were very non-detailed. They were not detailed at all in the sense that it was like, "Well, we investigated 10 banks and maybe half a page about what was wrong with these banks." So you couldn't quite tell which bank was involved in which bank had which deficiency, but it was all just very agitated.

Hal Weitzman: Why did they do it like that? Was there a legal case involved that they couldn't say the specific banks?

Rimmy Tomy: I think in general, it's just a case of the regulator not being very transparent.

Hal Weitzman: I mean, this issue of sort of contagion, I see one bank doing something bad, I sort of spread that ... Mentally, I spread that onto everyone else. It's interesting. And you've also looked at trust in other institutions, like the court system. So how does that change the way that people react to this kind of banking scandals?

Rimmy Tomy: Yeah. I mean, the court system is kind of a backstop in the sense that if things go wrong, if my bank goes under, is unable to return my funds, if I trust the court system, I would go to the court and try to get my money back. But if you don't trust the court system, then you're just more likely to react to negative news about the bank as well. And this is exactly what we find. We sort of look at areas within the country where there's higher trust in the court system and in banks versus lower trust in the court system and banks. And we find that our effects are magnified in regions with lower trust.

And one reason for that could also be that in the past when events like this happened, when a bank was failing, for example, the central bank limited how much depositors could withdraw. So even though the deposit insurance limit was 100,000 rupees, as a depositor, you could only withdraw say 1,000 rupees in six months. So now, for a large wealthy depositor, that's not a big deal. But if you're a smaller depositor, that's a significant liquidity shock. And therefore in anticipation, if you hear news like this, you're just more likely to go in there and get more money out.

Hal Weitzman: Okay. So we talked about in the US you saw that high quality borrowers are more likely to switch out of the bank that has these enforcement actions. What about more educated borrowers? Are they actually losing ... Is it trust that you said one of the reasons that people can move is pull their funds out because they have other options? So is it just they have more optionality, or is it that they're actually losing trust? How do you measure that?

Rimmy Tomy: So that is a difficult question. So we're not able to necessarily differentiate, because higher educated or highly educated borrowers, they might also be wealthier and therefore have more options, but they might also, on the other hand, be just more aware of these enforcement actions and therefore they might lose trust faster too, simply because they're more aware and they know what it entails.

Hal Weitzman: Okay. So you talked about how in India they gave this somewhat vague statement about the investigation and it's kind of raises the idea that regulatory transparency is a sort of double-edged sword because disclosure can lead to bank runs or it can drive away good customers. What do you think is the lesson from your research for regulators? Should they rethink how they share this kind of information?

Rimmy Tomy: Well, so I think the findings from our research are a bit more nuanced in the sense that when regulators are thinking about disclosure, they also need to think about the level of trust that borrowers have in banks, in courts, in the regulator themselves. Because how these disclosures get consumed or how they get perceived depends a lot on depositors and borrowers preexisting levels of trust in the system. Now, this is not to say that regulators should not disclose information, but rather to say that the way they disclose information, the amount of detail they provide in disclosing this information, all of those things go into building trust in a system and that's probably where they need to focus more.

Hal Weitzman: Okay. Rimmy Tomy, thank you so much for coming on the Chicago Booth Review Podcast.

Rimmy Tomy: Thank you.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis and insights, visit our website, chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research. This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.