Banks aren’t rewarding failure – but restrictions on bonuses could go too far

 
Anthony Browne
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WITH the predictability of “snowflake causes chaos” stories, we are entering the annual banker bonus furore season. With the economy in doldrums, and the industry in the doghouse, it is easy to understand the concern. Top bankers have themselves said that pay has been “grotesque.”

But just as predictable as the outrage is a lack of acknowledgement of how much has changed since the start of the crisis. Across investment banking, bonus pools fell 55 per cent between 2007 and 2011 (according to pay consultants McLagan), and are widely predicted to fall again this year. Overall, immediate cash bonuses are down 77 per cent in four years – a huge drop by any standards. Last year, financial services was one of the few sectors where bonuses fell – down 11 per cent, compared to a rise of 50 per cent in real estate and 11 per cent in construction (according to the Office for National Statistics.)

More importantly, bankers no longer get bonuses for taking short-term risks. By law, bankers have to have at least half paid in their bank’s shares, which are largely deferred for three years or more. For the higher paid, the immediate cash bonus must be at most 20 per cent of the total. The FSA has also introduced clawback: if it turns out an employee took reckless risks or behaved illegally, his or her deferred bonus can be cut or cancelled. No longer are bankers rewarded for their successes but not punished for failure. This sanction has been used in high profile cases.

I am often asked why bankers should be paid bonuses at all. Like employers across the UK economy, retail banks and investment banks find that performance-related pay is a useful tool to incentivise workers. In banking, profits rise and fall rapidly, and having a large proportion of variable pay means that, in down years, banks can cut pay rather than jobs. That leaves more people working – in the UK’s most successful export sector – to generate business when the economy picks up. If you got rid of bonuses, banks would only have the option of cutting jobs, hampering the recovery of the UK economy.

Banks have far more intrusive pay regulation than any other sector – it is a little appreciated fact that banks have to get their pay packages signed off by the FSA (no other sector has to go through this). London already has among the toughest bonus rules in the world, but more is to come. The EU is planning legislation that would cap the size of the bonus that banks can pay. It is a pan-European version of 1970s-style government pay controls, but applied to one sector.

There are downsides to restricting bonuses too much. Investment banking in London already pays less than in any rival financial centre, which impacts on the City’s ability to attract the top talent, and thus our ability to compete in the global market. The biggest loser from falling bonuses is actually the government – more than half the bonus pool is paid out in tax and national insurance.

Bankers’ pay needed to change. And it has. Continuing to bash bankers over their bonuses makes good headlines, but might not be the best thing for the economy.

Anthony Browne is chief executive of the British Bankers’ Association.