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Making allowances

9 October 2014 By Dominic Elliott

The European Union’s misguided bonus cap could yet be made to fit – if policymakers can square the circle on allowances.

Worried about staff defections, banks are paying regular stipends to top up fixed pay and offset lower levels of variable compensation. That mitigates the impact of the cap, which will limit 2014 bonuses to between 100 percent and 250 percent of salary on the – unproven – assumption that limiting variable pay also limits risk-taking.

Some policymakers don’t like the get-around. Outgoing finance commissioner Michel Barnier frets that banks are using them to trash the spirit of the regulation, and has asked the European Banking Authority (EBA) for its analysis of current market practice. The payments are permitted under the legislation, as long as they are linked to roles, not performance. Yet the more flex that banks build into allowances, the more they look like bonuses.

But with the right criteria, allowances could keep risk-taking down – the key goal of the cap – while satisfying banks’ desire to retain staff and maintain some flexibility on costs.

Guidelines from the EBA are due later this year. Ideally, these should constrain allowances from being paid as rewards for individual performance, and therefore incentives to take excess risk.

To achieve that, banks could be allowed to adjust the quantum of payments once a year at most, based on broad market conditions. Such allowances would diverge only moderately for staff with similar responsibilities. So if credit trading was buoyant, and such staff were relatively more valuable, those teams would enjoy an allowance. Next, allowances should be paid in cash or stock and a portion subjected to deferrals, malus and clawback. The end bonus, based on individual performance, would remain capped relative to base salary.

It’s not a perfect solution, not least because the thinking behind the cap is flawed to begin with. But permitting leeway on allowances would give banks more options to manage their risk. It could also prevent banks’ fixed costs from rising excessively, and make it easier for overall pay levels to fall.

It’s not clear the EBA will actually grasp the nettle. German watchdog Bafin has banned allowances, and France’s rigid labour laws would preclude even the most modest tweaks. But if it wants to think creatively, there is a solution.


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