Labour’s latest bout of banker-bashing is economically senseless

 
Allister Heath

BRITISH politics is so depressingly predictable. The cost of living crisis is abating (the gap between pay hikes and inflation is shrinking), there was one poor opinion poll for the Labour party (now reversed) and the economy is continuing to recover – so hey, presto, the Labour party has decided to start banker-bashing once again.

Its first target is RBS, even though the bank has now changed beyond recognition since Fred Goodwin’s disastrous days. Labour want the government to veto staff from earning more than 100 per cent of base pay in bonuses – even though other, rival banks are paying 200 per cent, and regardless of the state-owned bank’s ability to keep hold of the best staff in a rising market.

It is clear from their rhetoric that most Labour politicians don’t really like 100 per cent bonuses either; they seem to loathe all variable pay in finance, believing it to be somehow wrong and in need of punitive taxation. The (absurd) logic of the position, of course, would be to ban bonuses completely. This would mean banks hiking fixed pay even further – after all, total compensation levels are determined by supply and demand, so if one component of pay is reduced the other inevitably rises, as we have seen over the past couple of years as the industry has been told to drastically curtail its use of variable pay.

Would the Labour party be happy with that? Does it dislike bankers earning £1m in base pay and £2m in bonus, but is fine if they earn £4m or £10m in guaranteed pay? If not, what next? Caps on wages? And if you start with bankers, where do you end? Caps on all wages, or crippling, French-style tax rates on high incomes? And is the party aware that base pay is in cash – but that bonuses are equity-based, increasingly deferred and subject to claw-back clauses? Is it aware that banks with very large fixed costs are much riskier than those with bigger variable costs, and find it harder to stay afloat in a crisis? And that mass sackings will be required in downturns?

Cracking down on bonuses will have devastating unintended consequences, make the financial system more short-term, make the City relatively less appealing as a location for global business, and also wreck another Labour policy: the idea that massive new taxes can be imposed on bonuses (on top of the ever more onerous bank balance sheet levy) to raise vast amounts to finance extra spending plans. You can’t have it both ways.

RBS’s big problem is its sub-standard retail bank IT system. In theory, a healthy and profitable investment bank division could generate cash to help finance the required spending – but political pressure (and here the coalition is to blame) to downsize it and make it less competitive will actually make such a cross subsidy much harder to pull off now.

The good news is that it now seems as if Labour won’t be imposing specific limits – say 25 per cent – on the maximum retail market share a bank can have. These sorts of caps would mean that a bank that reached its threshold would have zero incentive to attract new customers – it would have to give another up each time it gained a new one. Competition, paradoxically, would actually decline. Service levels would collapse and the biggest banks would have an incentive to focus only on the most lucrative customers, discriminating against the poor.

The coalition’s new 7-day switching rules have fuelled a 17 per cent increase in switching in the fourth quarter of 2013, compared to the same period of 2012; there was a 54 per cent increase in December. Labour’s plan to launch a competition inquiry into retail banks is a total waste of time: it should focus instead on making it even easier to switch banks. It should back fully portable bank accounts, making it almost as easy to switch bank as it is to switch supermarket. That, rather than the usual mindless class warfare, would be a genuinely good idea.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

Related articles