Bank of England: Poorly designed banker bonus clawbacks can actually encourage risk-taking

Jessica Morris
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A city worker walks past the Bank of Eng
The BoE says bonuses should be linked to risk management (Source: Getty)

Poorly designed banker bonus clawbacks can actually encourage risk-taking and short-termism, according to a new blog post by the Bank of England.

It argues that bonuses linked to financial performance rather than risk management can encourage excessive risk-taking, as execs expect to suffer large losses when their firm performs poorly, meaning they’re more likely to become risk averse.

Earlier this year, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) confirmed they will push ahead with rules for a clawback period of up to 10 years.

The clawback periods are designed to give bankers an incentive to consider the long-term health of the companies they work for, instead of making a quick buck and leaving before losses they are responsible for become manifest. However there are concerns poorly implemented regulations will hurt London’s ability to compete with other financial centres, such as New York.

Read more: The UK now has the toughest bank pay rules in the world

“Importantly, the effectiveness of malus and clawbacks depends on how bankers expect them to be implemented,” the researchers wrote.

“Good risk management ex ante doesn’t mean zero risk, and bad outcomes at times occur despite good risk management.”

“So a well-designed remuneration regulation should lead the executives to believe that they will be penalised proportionately for losses that occurred because of their poor risk management, but not for losses that occurred in spite of risk management.”

But they acknowledged there are difficulties associated with how well managers mitigated risks several years later.

It would require documenting and recording the processes, models and analyses used for taking important risk decisions, and clear standards against which they can be judged, so they won't be held accountable for losses that happen despite good risk management.

However, if this can't be done, the researchers called for the use of bonus clawbacks to be scaled back.

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