2.1.3 Tackling the bonus culture and ring-fencing banks
A highly controversial issue that the regulatory authorities had to address in the wake of the financial crisis was how much blame should be placed on the high salaries paid to those making investments and undertaking other financial transactions – and specifically the bonus culture within the major banks and other financial firms.
Tackling the bonus and high salary culture
The observation widely made in the aftermath of the financial crisis was that the bonus system – with the investment banks historically being at the forefront in terms of the size of bonuses – encouraged excessive risk-taking. If the gambles made by the dealers in their investments came off, they got high bonuses. If the gambles failed, then the resultant losses had to be absorbed by the banks – or, more specifically, the banks’ shareholders. There seemed to be a clear message: curb the bonus culture and you prevent excessive risk-taking and avoid the risk of a repetition of the financial crisis.
The return of several of the major financial firms to profitability in 2009 and the subsequent triggering of bonuses for their staff prompted a robust response from the Labour government. In the pre-budget statement in December 2009, the then Chancellor of the Exchequer introduced a 50 per cent tax to be paid by the banks on bankers’ bonuses in excess of £25,000.
In 2009, the FSA produced a code of practice on remuneration for employees of financial firms. The code banned guaranteed bonuses for periods of beyond 1 year, stated that it expected two-thirds of bonuses for senior staff to be spread over 3 years and required financial firms to submit their remuneration policies for review by the FSA. The expectation was that such policies should be consistent with effective risk management practices at the institutions.
The code was criticised for being weak. However, the then chief executive of the FSA, Hector Sants, pointed out at the time that the FSA did not have the powers to determine how much employees of financial firms got paid.
In July 2010 the FSA announced plans to update its remuneration code to accommodate remuneration rules required by the EU’s Capital Requirements Directive (CRD3) and the Financial Services Act 2010. The new rules took effect from 2011 and require at least 40 per cent of bonuses to be deferred over a period of at least 3 years, rising to 60 per cent for bonuses above £500,000. In addition, at least 50 per cent of performance-linked remuneration must be in shares or in other non-cash form. In respect of guaranteed bonuses, these may not be for periods of more than 1 year and may only be given in exceptional circumstances to those newly hired by firms.
When, in February 2011, the then Chancellor, George Osborne, unfolded the Project Merlin agreement with the banks, it included stipulations on pay and bonuses. The agreement included a requirement for the UK’s top four banks (Barclays, HSBC, Lloyds and RBS) to publish the pay of their five highest-paid staff below board level.
From 2012 all large UK banks – including overseas banks with UK operations – have had to publish the pay of their board members plus that of the eight highest-paid staff below board level.
Some banks continue to insist that material bonuses need to be offered to ensure that they can attract and retain the best banking staff – and that high-quality staff are needed to ensure profitability. Indeed, the investment bank J.P. Morgan was reported in December 2009 as considering abandoning its plans to build a headquarters in London as a result of concerns about the 50 per cent tax on bonuses and the tightening regulatory environment in the UK (The Times, 2009b).