Take one more longing look at that new Ferrari, and one more peek at that brochure for townhouses in Mayfair or chateaus in Provence. Europe’s bankers should enjoy the bonus season. It may be the last.
Last week, the Committee of European Banking Supervisors (CEBS) announced a clampdown on bonuses. Bankers will be limited in the amount of cash they can receive. The bulk of their bonuses will be paid in shares. There will be clawbacks if the bank goes down the tubes.
The days when a job in finance was a way of getting rich quick and easy are finally over.
The trouble is, the committee may well have damaged the big names of Europe’s banking industry, such as Barclays Plc and Deutsche Bank AG. It has imposed far harsher rules than are likely to be applied elsewhere in the world.
Instead, it should have overhauled the whole system—rather than trying to micro-regulate banks that are no longer working the way they should. No one would deny that some review of the bonus culture was needed. Financial-industry pay has become a conspiracy against the public—and one that needed to be changed.
Traders take big bets with other people’s money. If they win, they collect a fortune. If they lose, they go and get another job and try again. Even some of the industry’s leaders have realized there isn’t much fairness.
“You can put on a large trade, and if it works, you make out like a bandit; and if it doesn’t, you might get fired, but you’re not paying back,” James Gorman, the chief executive officer of Morgan Stanley, said at a conference last month. So you have asymmetric risk: You either come out zero or you come out positive. That’s imbalance.
It won’t change by itself. There is little evidence the banking industry has fixed the way it operates since the credit crunch. One US study found things have worsened. According to a report commissioned by the Council of Institutional Investors, there is less of a link now between bankers’ pay and long-term performance than ever before.
Taxpayers, who now stand behind all the main banks, won’t stand for it much longer. Something needs to change.
In fairness, the CEBS has made a decent stab at altering the system. The new rules limit bankers to receiving about a quarter of their bonuses in immediate cash payouts, while the rest must be deferred or held in shares for a minimum of three years.
There will also be a link between fixed pay and bonuses, as well as a mechanism for making senior managers repay their bonuses if excessive risk-taking is later found to have caused financial problems at a bank. National regulators in the European Union will have to implement the new regulations.
It will make a difference. Big cash payouts at the end of the year were what caused much of the wild, dangerous trading within the banking system. The dice were always loaded in favour of taking that big bet on yak-hide futures. If your bonus was paid in shares in your bank, you’d be a lot more worried about its long-term prospects—and a lot less willing to risk it on one big bet.
But there are two reasons why the rules won’t work.
First, it will be very hard for European banks to compete with the rest of the world. Asian and US lenders won’t have the same kind of restrictions, though Wall Street pay will drop as much as 28% this year, according to New York-based consulting firm Options Group.
In any case, the best traders—those who get the calls right—may well head for Asia or New York. Europe will be left with the dunderheads. Is that what the EU intended?
Second, micro-regulations are tough to enforce. If you are going to try and get bonuses back from executives, how exactly do you prove that the risks taken were excessive rather than just the kind of transactions that banks do every day? In reality, the lawyers will have a field day. And very little money will get repaid. Regulators should have been improving the structure of the banking system, rather than trying to fiddle with how banks pay their staff.
The only solution to the bonus issue is to split the banks into their retail and investment-banking divisions—and then make the investment bankers operate as partnerships.
The retail banks can take in customer deposits, run payment systems, and make loans to individuals and businesses with collateral. These lenders can be protected by taxpayers from collapse. In return, the banks are run in a safe way.
The investment banks can raise their own cash from clients, and they can do what they like with it. That way, the traders are taking risks with their own money, or the funds of people who have invested willingly. If they do well, it’s great for them. If they go bust, it doesn’t matter to anyone else. There wouldn’t be any need to regulate them because it wouldn’t matter what their fate was.
That would create a banking industry that was innovative and creative—and yet not a danger to the economy.
Everything else is just fiddling with a flawed system.
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