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State paymasters

28 February 2013 By Chris Hughes

The regulation of pay in Europe marks an unwelcome watershed in post-crisis financial reform. European Union lawmakers on Thursday finally approved rules to cap bank bonuses relative to base salaries. Regulating for competition or financial stability is one thing. Intervening in how people are paid is quite another.

Full details of the proposals are yet to emerge. Broadly, all EU banks and foreign banks operating in member countries will only be able to pay bonuses of more than 100 percent of base salary if they have 66 percent shareholder support. Even then, the maximum ratio will be 1:2.5, and only if banks choose to pay a portion of the bonus in deferred stock or contingent capital.

Among its flaws, this puts banks out of kilter with other sectors. Take miner Rio Tinto. It appointed a new finance director just as the EU’s bonus caps were being disclosed. This is a big job with a base salary of 800,000 pounds. But the annual and deferred bonuses together are worth 3.3 times base pay.

Europe hopes the move will bring down bankers’ pay. It may. But the reality is that the labour market’s response to existing bonus curbs has been to demand higher fixed salaries. Competitive pressure has made it hard for banks to resist this. Increasing the relative contribution of fixed pay undermines all the good incentives embedded in short- and long-term bonus structures that reward good performance and claw back payouts when misdemeanours emerge. That’s why this policy could hurt shareholders far more than employees.

Sadly, these arguments are now largely academic. But bank management and investors must now ask how this situation arose. The answer is that the industry failed to engage effectively. Banking has a genuine problem with excess pay and excess risk taking. But banks and bankers have been slow to acknowledge this and offer solutions. True, Deutsche Bank’s Anshu Jain made lower remuneration a key message in his strategic review. But that was only in September and the industry is still awash with provocative pay deals.

The banks should have admitted the need for change and come up with their own ways of channelling more of their profit to capital, shareholders and taxpayers. Ineffective self-regulation invariably leads to bad top-down regulation in the end.

 

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