EU to prick bank bonus bubble

Bankers' bonuses look set to be officially deflated. But will a cap on payouts work?

by Andrew Saunders
Last Updated: 14 Oct 2010
The word on the street is that the 27 member Committee of European Banking Supervisors is about to recommend a formal limitation on the size of bankers’ bonuses. All the signs are that the cap will take the form of a multiple of basic pay beyond which bonuses may not extend – 20 times being the most oft-mentioned figure.

Not before time, some might say. The row over bonuses is already in its third year and about to enter a fourth. With no sign at all of any real action on the part of the banks themselves and the annual CEBR bonus survey predicting a return to pre-crash levels of reward in the City, it’s hardly surprising that the regulators are stepping in.

There’s no doubting the depth of public and political sentiment on the subject either – in fact the only people who don’t seem to get this are the bankers themselves, for whom any suggestion of official interference in this most sacred of rituals remains an absolute no-no.

But all this notwithstanding, the biggest question has to be, will such a cap work? And it’s not at all clear that it will. Cast your mind back to September 2008, when all this trouble started. Mega-bonuses came under fire not per se but rather because of the way they were applied. Huge payouts were being given for insanely risky trades that looked good in the short term but were disastrous in the medium to long-term.

That’s the structural risk that can arise from bonus schemes – it’s not the size of the payout that really matters in macro-economic terms, it’s what you have to do to get it. A truly Croesan pile may well be perfectly affordable, if its adequately tied in to long term performance measures. By contrast, one that’s limited to a given level may still encourage all the wrong sort of behaviour if it’s based only on immediate returns.

Focussing attention on the size of payouts rather than on how they are decided may leave the underlying risk profile – the thing that caused all the fuss in the first place - unchanged. Critics also claim that the multiple of base salary approach will simply force basic pay up to take up the difference – exactly the opposite of what is intended by the regulator. Although this may be a bit of red herring as the scheme seems likely to include a self-correcting mechanism to limit this effect.

Potentially much more serious is the prospect of these new rules applying not only to EU banks operating in EU territory, but also worldwide. That could leave us all with some seriously uncompetitive banks in the vital Asian and BRIC markets. Or, probably more likely, it could lead to a mass exodus of banks from London, Paris and Frankfurt in favour of Hong Kong, New York and Sao Paolo.

The debate goes to the heart of what the headshrinkers might call our society’s ‘conflicted’ feelings on the world of high finance. We don’t like bankers’ behaviour but we have become hooked on the products of their world – easy credit and access to a range of financial products the extent of which was unheard of only 20 or so years ago.

There’s also the undisputable fact that the City of London is home to one of the UK’s few truly world class industries. We must be very careful indeed that necessary reform of the financial sector does not turn into banker-bashing for the sake of it. If it does, we could drive this vital and highly mobile industry offshore for good.

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