What do YOU think?

So if it was up to you, do you think bankers deserve their bonuses?

Many people believe that bankers would have no alternative should they not be paid as highly or receive their bonuses. This however is not true, the best talent have other options. For example, Citigroup trader Matthew Carpenter  left the investment bank to work for a hedge fund. If banks were to face greater restrictions/reductions on their pay, over time we would see the departure of top talent; weakening the largest financial institutions and as a result weakening the financial system as a whole.

In an article I read, they used professional sports as an analogy for this situation:

Say a football team has a terrible year because their star goalie had a bad season. However the star striker led the league in scoring? Does this mean the club should not pay the striker generously to ensure that he stays with the team? And, if the team were to have an excellent season the following year, does that mean that players should not be paid due to the bad record from the previous year? Of course not. Such practices would be detrimental to the team.

I believe that the traditional bonus system is no longer promoting nor sustaining the banks’ financial performance in the long run. Bonuses based on annual performance create a short term incentive focus. However the elimination or capping of these bonuses is not a solution to the problem either and will simply damage the financial system further without doing anything to prevent future crises. More work needs to be done on creating a more effective incentive reward system; one where the individuals who are part of the failed system face huge losses themselves if their gamble does not pay off. This should promote the long term financial stability of the banking sector. This article sums up my opinion. 

The bank bonus issue is very controversial and it is one that is not going to be resolved easily. I believe that we will be hearing about bankers and their bonuses for quite some time to come. 

Public Opinion

Why are the public so against bankers receiving bonuses?

There is good reason why the public resent bankers and their bonuses. During the financial crisis many banks had to be bailed out using tax-payers money. However, despite this, many bankers have still been on the receiving end of whopping bonuses. When the banks performed well; their employees were paid well. However when the banks performed poorly; their employees were still paid well. Bonuses and compensation did not vary significantly as profits shrank. In the eyes of the public, their money is being used to bail out the banks but the bankers are still getting the enjoyment of these huge payouts. Also many banks have been associated with scandals such as the Libor rigging scandals yet the culprits are still being rewarded. 

We don't get rewarded for failure, so why should the banks?

EU Proposals - Bad Idea?

It is thought that the European parliament and EU states could reach an agreement on Wednesday whether or not to go ahead with the planned caps on banking bonuses as negotiations are due to be resumed.

As I talked about in my previous post, Britain is very anxious over these new plans which may trouble the city of London, the world’s financial capital. The UK is in favour of discouraging upfront cash bonuses that exceed salaries. It wants bonuses to be issued in the form of equity or bonds meaning that bankers will have a greater interest in the long term performance of their banks and will adjust their risk policies accordingly. At the minute, clawback provisions allow banks to retrieve bonuses from bankers who played a part in the failure of the bank The EU changes that bonuses may equal but not exceed salaries are very restrictive. The obvious way around this would be simply to give bankers a huge pay rise. Banker’s remuneration packages would be the same as before however it would be harder to clawback remuneration when things have gone wrong.

Andrew Bailey, the UK’s chief banking supervisor, believes this will harm the banks’ ability to build up capital. At a recent conference Bailey said he was “skeptical and concerned” about the plan to limit bonuses, because it would “make the cost base inflexible and make it more difficult to retain earnings and build capital.”

Having reached it's peak of £11.6 billion in 2007/2008, the bonus pool in London is set to fall to £2.3 billion is 2012/2013 according to the Centre for Economics and Business Research. The healthier climate for banking in the United States and Asia combined with the new bonus cap could be enough to encourage bankers to move abroad and this would come as a problem for many City firms.  

However it doesn’t seem likely that Britain is going to win this argument. "A cap is the only way we will see bonus restraint," said Arlene McCarthy, the British member of the European Parliament who pushed for pay reform. "The parliament is not prepared to budge. Legislators have got fed up because they don't see any restraint in the bonus culture."

I guess all will soon be revealed….

EU Bonus Crackdown

Banker’s bonuses are set to face the biggest crackdown from the European Union since the financial crisis in 2008.  The European Union are considering banning upfront cash bonuses that are greater than annual salaries, therefore holding banks to a 1:1 bonus to salary ratio. There is a possibility of this ratio being raised to 2:1 under the support of the majority of shareholders, i.e. if three quarters of a bank's shareholders agree. This new scheme is part of a plan to implement the new Basel III rules aimed at improving the stability of the financial sector in order to avoid a repeat of the recent financial crisis.

Banks were preparing themselves for a fixed cap on bonuses so these new proposals come as a shock to the system for them. The industry was relying on the UK and Germany to put pressure on to reduce the limits being imposed on bonuses. However, many countries, including Germany, are now backing these new plans in an attempt to avoid any disruption to the implementation of the new Basel III rules, much to the UK’s dismay.

British officials are said to be desperate to obtain adjustments to these new proposals, suggesting alternatives which will remove elements that they fear might backfire.  British officials believe that that these new EU proposals for a fixed bonus to salary ratio will only encourage banks to increase their already large fixed cash salaries. British officials added:

"We’ve always been in favour of a rigorous regime, but we need to make sure any reforms don’t create unintentional incentives that actually achieve the reverse of what is intended."

New Year, New Taxes

With the start of the new tax year we will see a reduction of the top rate of income tax. From 6^th April, the top rate of tax is set to fall from 50% to 45%. Since this news was announced by Chancellor George Osborne in last year’s budget, many banks and institutions have been considering deferring the payment of this year’s bonuses until the new tax year in order to avoid paying tax at the higher rate and enable them to exploit the new tax cuts. This move would enable banks to make a huge saving on the post-tax income of high earning employees.

HM Revenue & Customs are said to be looking at this issue of deferring bonuses very closely, and any worker who does not receive bonuses this year as determined in their contract could face the risk of incurring a ‘punitive fine’. To avoid any problems, changes will need to be made to employee’s contracts regarding when bonuses are paid. Employees will need to waiver their bonus for the current tax year until the following year.  However it may be very easy to get these details incorrect and so businesses will need to be careful as any errors in deferring bonuses could lead to a costly punishment on their behalf.

With so much negative publicity recently surrounding tax avoidance, such as the Starbucks tax scandal, as shown in the clip below, it is likely that many banks will reject this move in order to avoid criticism and the risk of provoking anger from the rest of society. Goldman Sachs has already decided against deferring its bonuses this year following much criticism surrounding the speculative move.

The motivation behind bonuses

Why do banks pay bonuses? The underlying motivation behind them is to reward bank employees when their efforts produce profits for the bank. These bonuses can vary from thousands to millions of pounds and can be paid to bankers in cash or also in less obvious forms such as shares or pension funds. The allocation of such bonuses is decided by the bank’s remuneration committee.  

However within the financial world how do banks make more money? They take more risks! Bonuses are seen by many as short term incentives which can trigger excessive risk taking by banks. These incentives cloud good judgement in investment bankers, and rather than making them better bankers, it instills greed. This is a fault which helped contribute to the recent financial crisis. This leads us to wonder why banks pay these bonuses which encourage risk taking? The main explanation behind this is the competition for managerial talent; due to rising competition banks need to offer bonuses to be able to maintain and attract the best staff. 

“Banks operate in a world where their star talent is apt to jump between different groups, whenever a bigger pay-packet appears, with scant regard for corporate loyalty or employment contracts. As one banker says ‘These bonuses are crazy; we all know that. But we don’t know how to stop paying them without losing our best staff.’ ”(Tett, 2009)

Bonus Season

We are currently in the midst of the bonus season, with many banks having already announced their bonuses for this year.  The chief executive of Barclays bank, Antony Jenkins is among the latest to forego his £1m bonus this year. His decision to accept this bonus would have caused much controversy following the bank being fined £290m for rigging the benchmark Libor rate and also the mis-selling of payment protection insurance for which the bank has set aside £2bn to pay for claims. You can read more about this issue here Barclays Libor/PPI scandal.

Antony Jenkins has said in a statement:

"The year just past was clearly a very difficult one for Barclays and its stakeholders, with multiple issues of our own making besetting the bank. I think it only right that I bear an appropriate degree of accountability for those matters, and I have concluded that it would be wrong for me to receive a bonus for 2012 given those circumstances."

His decision to waiver his bonus follows that of Stephen Hester, chief executive of Royal Bank of Scotland, who has already decided to renounce his bonus following the bank’s computer crisis scandal last year. This move will pressure other top bankers to follow their example. António Horta-Osório, chief executive of Lloyds Banking Group, and Stuart Gulliver, boss of HSBC, are both yet to announce whether or not they will be accepting this year’s bonuses. These two banks have also faced scandal this year and the bosses could face interrogations about their decisions to accept these bonuses.  

The issue of banking bonuses is one of great debate within the financial sector. In this blog I will explore this area further, looking at the reasons why banks pay bonuses, the taxes imposed on them, public opinion of bonuses and whether or not this could be the end of such big bonuses?