Greg Clark is Financial Secretary to the
Treasury and MP for Tunbridge Wells. Most Tuesdays he will be writing
this new 'Letter from a Treasury Minister' for ConservativeHome readers.
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A rite of spring is upon us again: the banks’ bonus announcements. For years now, these declarations have become an annual focal point of public anger. Certainly, many of the problems – and scandals – of banking in this country and overseas can be traced, directly or indirectly, to the way some people have been paid in the industry.
In the run-up to the financial crisis, trades and transactions in products of dizzying complexity were made by people whose apparent success was known to trigger National Lottery-style payouts – sometimes in advance of any profits actually being realised. With the downside risk of these bets falling on shareholders or – as it turned out – taxpayers, the gross distortion of appropriate behaviour driven by bonuses contributed to the vulnerability of the entire banking system.
Then – and now – we must never forget that the ultimate source of the money paid out to the Masters of the Universe was not some process of alchemy, but, in large part, the hard-earned cash of those who Leona Helmsley contemptuously called “the little people”: pensioners, whose investments were put into the British banking industry, that bluest of blue chip sectors; businesses, who saw funds that might have been available to finance their growth being diverted to pay packets; and taxpayers, each of whom had to stump up £2,000 to save RBS and Lloyds.
Moreover, it’s clear that the practices of the worst investment banks curdled the culture of parts of domestic retail banking too – as demonstrated by the payment protection insurance and interest rate swap scandals. In these cases we see how badly structured bonuses and commissions have distorted incentives and undermined responsibility.
But why does banking need bonuses anyway? ‘To incentivise the right behaviour’ is, of course, the stock answer. Yet the vast majority of ordinary working people in this country go to work and do their job to the very best of their ability because it is, quite simply, a matter of professional and personal pride to do so. Of course, a modest bonus by way of a pat on the bank for good work is always welcome. But how many of us would do a lazy or lousy job unless we were promised some vast additional payment? Virtually none. So why is it that some of the most sophisticated and financially-comfortable people in society are seemingly assumed to be so bovine in their behaviour that they can only be relied on to do their job properly if they are offered the prospect of an enormous dollop of extra feed at the day’s end?
No wonder the bonus round excites contempt. So why do we have to put up with it?
First, investment banking – though less so retail banking – is an international business. Most of the banks trading in the City are headquartered overseas, and almost all have substantial operations in other financial centres around the world. Many of the staff of any given bank in London are citizens of other countries who choose to work in London because of its attractiveness as an international financial centre. There are international norms in an international industry, and when it comes to pay, a few positions in global banking are exceptionally well-paid.
Whether we like it or not, it would be hard for Britain to maintain its prominence as one of the world’s leading centres of international finance (the UK is the world’s largest foreign exchange market with 37 per cent of global business, and has 46 per cent of the world’s trade in over-the-counter derivatives) without operating in international personnel markets. Just as the prestige of the English Premier League requires being competitive in the market for the world’s best – and best paid – footballers, so we can’t rely on being a global player in finance while divorcing ourselves from what happens elsewhere.
Connected to this, there is a technical argument for the astonishing rewards that are sometimes paid in banking. The sums of money at stake mean that quite small differences in the performance of individuals and teams can result in differences of hundreds of millions of pounds in the performance of a bank. If a higher reward can attract a more capable individual or team, it might be a false economy for shareholders to tie pay back to a more modest level. The six premiership goals this season that separate Robin van Persie of Manchester United and Gareth Bale of Spurs may prove to be the difference between winning the title and coming fourth – with multi-million pound consequences.
Providing that no costs or excessive risks are imposed on UK taxpayers, should the level of pay in the many privately or foreign owned banks which operate in London be any more relevant to policy makers than what Sir Richard Branson is paid? And, of course, every employee who works in the UK, and every pound of every bonus, and every pound of profit made contributes directly to other taxpayers through income tax and national insurance, corporation tax, stamp duty, capital gains tax and VAT – as well as the contribution they make by employing others and spending money with other businesses. UK financial services contribute £1 in every £8 of the taxes that pay for our public services – a golden goose that it is in all our interests to keep in rude health.
If we want banks to pose less of a threat to the stability of our financial system, there is good reason to prefer that they should be flexible rather than brittle in response to changing trading conditions. The more of a bank’s costs that are tied up in fixed salaries rather than variable bonuses, the more concerns there are about its ability to withstand turbulence.
These considerations must guide how policymakers address the awkward questions that are provoked by each year’s bank bonus round. I believe that five principles should shape the policy response.
First, in a global industry, we should look to resolve many of these tensions at the international level. Britain needs to be globally competitive. Unilateral action – however well-intentioned – at the UK or EU level that does not take sufficient account of international norms risks downgrading Britain’s position as a successful international centre, to the detriment of jobs, tax revenues and export earnings. That is why it is right that the global Financial Stability Board – chaired by the Bank of England’s Governor-designate Mark Carney – should be the leading forum for agreeing global principles and implementation standards for bank remuneration. Under the FSB, all G20 countries are implementing standards which require pay to be safer, more transparent and more recoverable in the event of failure.
Second, we should enhance the role of shareholders in exercising genuine discipline over the managers they employ. Under reforms introduced by this Government, shareholders will have a binding vote on executive pay and bonus arrangements.
Third, regulators must be constantly assured that banks’ remuneration policies pose no risk to the stability of the financial system – or to the taxpayer. Under reforms we have introduced, banks have to share their remuneration policies with the Bank of England and the Financial Services Authority, who have the power to prevent levels or structures of pay that would undermine a bank’s capital position or provide incentives for a dangerous level of risk-taking.
Fourth, bonuses should no longer be a one way, short-term bet for managers and traders, but should more accurately reflect the longer-term interests of the company. Under the FSA’s Remuneration Code – co-ordinated with the global Financial Stability Board – immediate cash bonuses for risk-takers must be restricted to 20 to 30 per cent of the total. The rest must be deferred or paid in shares which can be clawed back in the event of underperformance or misconduct that comes to light later – as was the case with RBS last week in the case of its fine for the attempted manipulation of Libor.
Fifth, no bonus scheme should be allowed which operates to the detriment of consumers. The FSA are acting to ensure that the sales commissions that drove the mis-selling of PPI and interest rate swaps to small firms cannot happen again.
At a time when many people are going through painful economic times, the sight of bonuses for bankers can be hard to take. Every institution paying a bonus this year should – as a matter of good business practice – respect and reflect the consequences for shareholders, customers and financial stability of what is allocated.
To the lasting shame of the previous Government, the out-of-control bonus culture of the recent past effectively obliged the taxpayer to provide the stakes for a series of reckless, one-way bets. The lasting legacy of this Government will be to ensure that the risks and the rewards of investment stay where they belong – with an independent and responsible British banking sector.