As the Eurozone crisis continues its present contagion trajectory (stimulated by the apparent lack of a ‘big bazooka’ solution to end the continuing speculation about the survivability of the euro), there is growing concern again about bankers’ bonuses. Bankers alleged high pay and ‘excessive’ bonuses were seen by many as a typical feature of the kind of ‘bad banking’ that helped fuel the build up to the crisis (the ‘credit crunch’) that began in 2007. Another and not unrelated feature of this kind of ‘bad banking’ is the dominant and pervasive bank selling and ‘sales targets’ culture, which is itself bonus-driven.
Despite calls for restraint from the governor of the Bank of England, the UK Barclays Capital plans to pay its investment bankers £5 billion this year. This means that its 21,400 staff will each receive an average compensation (this includes all salaries, bonuses and pay-related perks) of £210k. The Bank of England has warned banks to ‘limit distributions’ (which include staff bonuses and dividends to shareholders) in order to help preserve their own equity capital. This kind of ‘Tier 1’ bank capital is needed to help support lending growth, which must be maintained if another severe ‘credit crunch’ is to be avoided or at least mitigated.
The banking industry has been widely vilified over its bonus culture and salary levels in general. The recent anti-capitalist protests in the US, London and elsewhere are a dramatic example of this. A recent Sunday Times (interview with Michael Spencer, Chief Executive of Icap, a multinational brokerage based in the City) argues that pay ‘needs to come down a long way’. He adds that compensation levels in the financial industry are calming down, but there is still a long way to go.
Recent criticisms on bank compensation packages for some top executives whose performances have been criticised widely do not help the public image of banking. Fred Goodwin, the former Head of RBS (Royal Bank of Scotland), and Eric Daniels of Lloyds fall into this category. Both presided over takeovers that proved disastrous for the two banks concerned – HBOS in the case of Lloyds and ABN Amro for RBS. Whatever the merits of such criticisms, they have helped to reinforce banking’s ‘bad press’ on bonuses and compensation packages in general.
Against the backcloth of the eurozone crisis, anti-capitalist protests and the growing threat of ‘double-dip’ recession, bank bonuses are again in the headlines. David Cameron, the British Prime Minister, has been critical of bank bonuses in general and (recently) RBS in particular. It has been reported that David Cameron has threatened to block RBS bonuses reported at £500mn. The Sunday Times recently pointed out that traders at RBS’s investment banking operation (which is barely breaking-even and is shedding jobs) were being paid an estimated 75p for every £1 of sales made for the bank. Cameron has also repeated his strong message that the UK 50p tax rate on individual earnings above £150k per annum will remain for the foreseeable future.
Nevertheless, it does appear that banks have made many positive moves to reduce pay and bonuses compared with pre-2008 levels. The Centre for Economics and Business (CEBR) expects the upcoming round of bank bonuses to fall by around 40 percent compared with last year’s. UK bank bonuses rose from £9.6bn in 2005/06 to a peak of £11.6bn in 2007/08. In 2009/10 they were £7.6bn and 2011/12 estimates are of the order of £4.2bn. It has also been reported that Lloyds Banking Group has imposed a pay freeze on its top executives and aims to slash bonuses by at least 10 per cent.
On December 8, George Osborne (the British Chancellor) issued his toughest warning yet to banks that they should curb bonuses next year. He has threatened ‘consequences’ if the banks do not voluntarily curb staff pay-outs. ‘Consequences’ mean tougher bank regulation, including the public disclosure of top executives’ compensation packages. Mr Osborne echoes the warnings given by the Bank of England on this same issue. Banks should curb bonuses and pay-outs in order to build up stronger capital in the face of a growing risk of possible contagion, financial crisis and, at the very least, severe recession pressures. Vince Cable, the UK Business Secretary, has added recently a strong threat of higher taxes on banks unless they show restraint with their bonuses.
Bank shareholders have also added their weight to this lobby. The Association of British Insurers (ABI) has publicly criticised the banking sector and demanded that it takes a ‘responsible approach’ to payouts at a time when the rest of the UK is under pressure. This move by the Association (a lobby group that represents some of the largest investors in the UK and around a sixth overall of UK shareholders) is unprecedented. They are urging the banking sector to undertake a ‘root and branch’ overhaul of pay structures and a cutting back on bonuses to individuals.
This tough missive from the ABI to the banking sector warns that shareholders are expecting ‘significantly less bonus pools and awards given to individuals given the state of the market and economic environment’. High up on the ABI’s list of grievance is that executive rewards tend to multiply, irrespective of shareholder’s returns. They are also concerned that banks will reduce shareholders’ dividends to help build up their capital in the face of the growing, recession-induced need to strengthen bank capital. ABI argues that cutting back pay and bonuses must be part of these same bank capital-building moves.
Leading fund managers in the City (London’s financial city) have also attacked the apparent generous pay increases at big City banks. It is reported that the UK’s biggest investment groups have recently met bank boards and argued for pay and bonus restraint, especially in investment banking divisions. A key argument here is that banks must now focus on re-building investors confidence, which will be critical in the capital-raising that banks need to undertake. Banks must re-balance their priorities back to shareholders and away from executives pay.
As bank profits come under strain and jobs are shed, the economic pressure on banks to reduce ‘pay and perks’ seems to be a logical response. The problem, though, is that banking and financial services are a vital industry (accounting for around 10 percent of GDP) for the UK. London (with New York) is one of the world’s leading financial centres. As David Cameron’s actions last week at the eurozone summit (9 December) have indicated, when London and UK financial services are threatened (in the European context, by higher taxes and more restrictive regulations), the UK Government has to respond. In many respects, this is a kind of European political dichotomy between so-called ‘Anglo Saxon’ banking (driven primarily by the market) and historic continental-style banking, where banks are seen as having a stronger socialist and wider stakeholder mission.
The problem for UK banking is that it competes for its top talent in a global marketplace. If the UK is ‘excessively strict’ on a key regulation (that is, out of line with other leading countries), then banks based in London may move to these other centres and/or find other ways of avoiding the penal regulation. These moves result in a cost to London – a reduced clustering of banks and other financial services in the UK (especially London), a potential lesser global role for London and less tax revenue to the UK Government from banking and financial services.
Already US banks based in London have intimated that they are prepared to snub the plans of UK regulators and shareholders for pay and bonus restraint. City experts also predict that foreign-owned banks will resist the call for greater transparency on bank pay and other areas.
The threat of banks moving out of London if pay-related or other UK regulations intensify is a real one. There have been rumours in the recent past about HSBC considering such a move. At this time there is speculation that Standard Chartered may also be considering a re-location of its headquarters.
The economic reality is that the UK Government has to recognise and protect London’s key position in global finance. Bankers also argue that many other ‘professionals’ earn high salaries – so why should bankers be ‘picked on’? Are David Beckham’s, Wayne Rooney’s and Andy Murray’s compensation packages vilified by the press…?
Nevertheless, there is an apparent groundswell of concern about bankers’ pay and bonuses. This cannot be denied or ignored. It is also a global concern for a major banking country like the UK that competes in the global marketplace. This means that there has to be a globally-agreed regulatory response. This will not be easy since the battle to attract financial services from one jurisdiction to another is an intense and continuing one. Without a globally agreed and instituted response, though, countries will target to compete business away from the stricter regimes (that is, from those countries that attempt to ‘go it alone’ on restraining bank compensation packages).
Another needed move is to encourage the ‘free market’ model to work more effectively in restraining excessive bank pay and perks. In practice, this means shareholder groups putting the needed ‘governance’ pressures on banks. So the recent UK ABI and hedge fund moves in London are welcome ones. Improving bank governance (disciplining by the free market) has to be a key driver for ensuring that bank excessive pay and perks are curbed. As with bank regulation, this needs to be facilitated and actively encouraged at a global level.
Professor Ted Gardener
