Bank bonus caps

How concerned should we be?

News that the European Union is to impose bonus caps on banks has shocked the City.  The measure, brought via the European Parliament, is ostensibly to protect the financial system against excessive risks being taken.  There seems no likelihood that the measure will be reversed, though its implementation may be delayed a year or so (the Financial Times has a useful Q&A on the subject here).

Critics of bonus caps say that it will lead to unintended consequences.  One of these, which does seem likely, is that 'basic' salaries will increase.  If London (or Paris, or Frankfurt) is competing in a world market for investment bankers, some way will be found to be competitive with regard to remuneration.  The result could be less flexibility in banks' cost bases because pay will not rise and fall so much with performance/profits.  Whether that will exaggerate the normal hire and and fire nature of investment banking or make employment more 'sticky' remains to be seen.  Another unintended consequence, much debated, is that banks could relocate operations outside the EU, to the EU's (and UK's in particular) detriment.

Banks can learn a lesson from this episode.  By refusing to admit to mistakes soon enough during and after the financial crisis, they have ensured their own voice is marginalised.  We always seem to hear them trying to maintain the status quo, to retain their previous freedoms.  Yet their actions, and their business models, during the crisis, changed things.  It now is very easy to 'bash the banks' and difficult to speak up for the essential roles we need banks to play in our economy.  The result can be bad legislation.  So the lesson banks need to learn is that they need to do more than just be a bit more ethical; they need to participate constructively in a debate about what reforms our banking and wider financial system still need.

As for the bonus cap - the usual rule of thumb when banks complain is that it is mostly noise and they quickly adjust to new operating environments.  There will be some of that in this case (what happened to all those bankers who were going to relocate to Switzerland because of the UK's bonus tax?).  The measures proposed appear to favour longer term bonuses, which is a good thing (there are few details announced).  Some sort of control over banking pay is required across the sector and on a global level.  This measure would have been better if it had controlled overall bank remuneration.  The push towards longer term rewards is good but more thought could probably have gone into that.  The ability - or will - of the majority of shareholders to properly control bank pay on a global scale, remains limited despite the fact that the remuneration packages of investment banks effectively pay shareholders funds to a small group of employees; funds which could be helping the pensions of ordinary people for example.

Stephen Beer, 05/03/2013

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