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Osborne gets it wrong on cash bonuses

Allister Heath

AS bizarre policies go, the Tories’ latest thinking on bank bonuses takes some beating. For this year only, Britain’s commercial banks will not be allowed to pay more than a trivial bonus in cash – but they will be able to pay as many millions as they want in shares. The rule will only apply to UK commercial banks, not to investment banks and not to UK subsidiaries of foreign banks (such as Goldman Sachs), hedge funds or anybody else. The idea is that if all the bonuses were paid in shares, billions of pounds could be retained by the banks, adding to their capital reserves – and according to the Tories, allowing them to lend more to consumers and business.

The speech doesn’t make it clear whether shares could be sold off straight away (which would make the policy meaningless); or whether they would have to be held a long time. If the latter, would it mean bankers would only have to pay capital gains tax at 18 per cent rather than income tax at 40 per cent (more with national insurance)? There would be huge contractual issues as well as a good case to take the UK to the European courts over discrimination (only UK banks would be affected, not other European firms in London). The compulsory dilution of banks’ long-suffering private shareholders will make it even harder to raise capital.

The Tories are persisting in their belief that there is a moral equivalence between RBS, which went bust and had to be nationalised, and HSBC, which didn’t take any money from any government. Talk of moral hazard: regardless of how well you do, you will still be hammered by the government. The speech also wrongly claims the policy is similar to that pursued by Barack Obama: but his policy to cut cash compensation only applies to 175 individuals at truly bailed-out firms such as AIG, Citigroup or Bank of America – not any of the other retail banks.

It is also not really true that the banks are refusing to lend. While bank lending (including overdrafts) to small businesses is hardly buoyant and interest rates have rocketed, the stock of lending has grown by over 4 per cent in the last year. Gross lending is strong; but there is also a lot of repayments taking place. Many individuals and firms are rightly repaying their excessive debt; the demand for credit, not its supply, has gone down.

Another flaw at the heart of the Tory argument is that they want margins on loans to go down and for banks simultaneously to hold more capital. Yet these variables are inversely related. Market forces determine return on capital, the rate at which shareholders wish to be remunerated. A bank that holds little capital can charge narrow margins on loans and still make enough money for every £1 of capital. A bank that holds lots of capital will have to charge much more to ensure that every £1 of capital still makes as much. Osborne’s plan could actually lead to less, rather than more, lending. And why does anybody want to go back to bubble-levels of lending at the old, ridiculously low, interest rates?

The Tories may be plotting to unilaterally enforce a Glass-Steagall policy through the back door by making it too tough for retail banks to own bonus-hungry investment banks. If so, expect HSBC and Barclays to start working on their exit plans: no other country, including the US, is planning this sort of separation. How baffling. allister.heath@cityam.com