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S federal regulators recently unveiled that since 2011 Wells Fargo and Co. (WFC) employees had secretly created millions of unauthorized bank and credit card accounts — without their customers knowing it.

The American international banking and financial services holding company has agreed to pay US$185 million in fines along with $5 million to refund customers and it fired 5,300 employees after admitting they had secretly set up more than 2 million unauthorized accounts to meet sales targets.

WFC was founded in 1852 and headquartered in San Francisco, California, with “hubquarters” throughout the country. It has been the world’s largest bank by market capitalization since July 2015 and surpassed Citigroup Inc. at the end of 2015 to become the third largest bank in the US by assets.

Wells Fargo is the second largest bank in deposits, home mortgage servicing and debit cards.

Reputational risk could hamper Wells Fargo. Reputational risk is the risk of damage to a bank’s image and public standing that occurs because of some dubious actions taken by the bank.

Sometimes reputational risk can be caused by perception or negative publicity against the bank and without any solid evidence of wrongdoing. Reputational risk leads to the public’s loss of confidence in a bank. Reputational risk sometimes creates other problems that a bank could have avoided.

According to the Brand Finance, the Wells Fargo brand value is the world’s top bank with a $30 billion brand value for 2014. The bank’s failure to honor commitments to the government, regulators and the public at large damages the bank’s reputation.

It can arise from any type of situation relating to mismanagement of the bank’s affairs or non-observance of the codes of conduct under corporate governance.

Risks emerging from suppression of facts and manipulation of records and accounts are also instances of reputational risk. Bad customer service, inappropriate staff behavior and delay in decisions create a bad bank image among the public and hamper business development.

There are at least three factors pointing to the fragile condition of the US banking sector that we can learn from the recent phony accounts made by Wells Fargo.

First, moral hazard is a problem of the bankers. Moral hazard refers to a situation in which a person, a group or an organization is likely to have a tendency or a willingness to take a high-level risk, even if it is economically unsound.

The reasoning is that the person, group, or organization knows that the costs of such risk-taking, if it materializes, won’t be borne by the person, group or organization taking the risk.

Economists describe moral hazard as any situation in which one person makes the decision about how much risk to take, while someone else bears the costs if things go badly.

In the case of the fake accounts at Wells Fargo, spurred by sales targets and compensation incentives, employees boosted sales figures by moved funds from customers’ existing accounts into newly created ones without their knowledge or consent.

Customers were being charged for insufficient funds or overdraft fees — because there wasn’t enough money in their original accounts.

Second are customer protection violations. Wells Fargo’s violations include opening deposit accounts and transferring funds without authorization, applying for credit cards without authorization, issuing and activating debit cards without authorization and creating phony email numbers to enroll consumers in on-line banking services.

The internal supervision system of Wells Fargo proved ineffective to prevent such customer protection violations. The system was proven inadequate in monitoring, detecting and resolving the problems and the risk exposures.

Third is regulatory monitoring and supervision. The banking and finance industry is a complex and sophisticated industry. A strong regulator is essential to ensuring that market players are telling the truth.

As the financial services industry becomes increasingly sophisticated with numerous derivatives, a special law, like that in the US, will be required to protect financial consumers from fraudulent services and products. The conditions described above clearly show that one of the root causes of the Wells Fargo case was weak governance.

According to the World Bank, corporate governance is a set of rules, standards and organizational concepts in economics that regulate the behavior of a company, directors and managers.

Included in this is a detailed descriptions of powers, functions and responsibilities of each of these parties toward investors.

The Bank for International Settlements (BIS) issued a document called Enhancing Corporate Governance for Banking Organizations. Based on this document, this implementation of good corporate governance in the banking system needs to follow a basic guideline.

The implementation of good governance will boost market confidence. Indonesia has experience during the crisis period that demonstrates just how much difficulties with market confidence over transparency of economic and financial fundamental can trigger market reactions leading to uncertainties.

However, we should take a note that the various actions and regulations aimed at strengthening good corporate governance in the banking system do not guarantee that banks have properly instituted good corporate governance. Experience shows that the effort to build good corporate governance remains dogged by such issues as poor employee integrity or moral hazard problems.

The key principles to in good corporate governance are transparency, responsibility, fairness and responsibilities.

We also should put more emphasis on ethical banking practices such as Islamic banking that promotes more justice, fairness and transparency in their operating system using a profit-sharing mechanism to ensure that all the interests of the stakeholders are protected.
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The writer is vice president of Shariah and MSME Academy head.