Can the market alone decide bankers' pay?

Dubai: Many top bankers — especially those in the high bonus bracket — seem to not quite understand the big noise the regulators, the media and the politicians make on their ‘well-deserved' big payouts.

While some bankers dismiss the public outrage as an expression of envy, others think it is a blatant violation of the basic principles of the market economy that glorifies the virtues of competition.

Clearly banks across the world are facing the ire of the man on the street for failing to show restraint on pay for executives when thousands of jobs are being cut and wages slashed or frozen following the financial crisis and recession that was largely blamed on banking sector excesses.

Despite the hue and cry from various quarters, in utter disregard for public sentiment banks went ahead and rewarded their key staff handsomely last year.

Standard Chartered's eight highest-paid bankers took home a combined $53 million (Dh194 million) in 2011 as the bank reported its ninth year of record profits. HSBC's eight highest-paid bankers received £30 million. Barclays Chief Executive Bob Diamond's payout was an estimated £17 million (Dh99 million) in deferred payments and shares which eclipsed most big banking sector CEO rewards in Europe last year. But according to Barclays own admission Diamond was not the highest paid executive in the organisation. And additionally the bank also paid 238 of the bank's senior staff an average of $1.8 million.

Despite losing billions in 2011, bailed-out British banks, including Lloyds and RBS, continued to pay millions in bonuses to its top executives. RBS reported payouts of £820,000 for its 386 so-called "code staff". However, coming under huge public pressure RBS boss Stephen Hester had to waive his £963,000 bonus. By no means can anyone argue that Hester is a lesser CEO than his counterparts at the helm of other banks who got away with fat paycheques. However Hester faced a bigger share of public pressure because his bank, which made $2 billion losses last year, is 83 per cent government owned and was bailed out with £45 billion of public money.

Should Hester be deprived of his bonus because he is heading a public sector bank that continues to make losses due to legacy issues? Shouldn't he too be rewarded for his efforts to turn around the troubled bank in the face of intense competition?

Regulators under pressure

Giving evidence to the Treasury Select Committee on RBS pay deal recently, Robin Budenberg, who is in charge of the body that manages the UK taxpayers' stakes in the banks, told members of parliament that Britain had a choice of either paying the market rate for top bankers or doing away with any pretence of competition. The committee is reportedly looking at the possibility of inserting clauses in the UK government owned banks' remuneration policies that would mean the bosses benefited if the taxpayers did too.

Regulators across the West have come under intense pressure to rein in rewards after several lenders were bailed out by taxpayers in 2008. In recent years bonus structures have been overhauled, with big chunks deferred and paid in shares rather than in cash up front. Although payout structures have changed, the size of rewards still remains a contentious point.

It is not too baffling to find that despite the worldwide protests against the big pay culture, bank managements continue to pay top dollars to their key employees. Rewarding success is the biggest defence in favour of the big paycheque. In the world of big bucks banking proven talent is a limited pool. In investment banking which has emerged the key driver of profits of large banks, reward is a function of individual performance. Prior to the financial crisis when banks turned in profits year after year, there were fewer complaints about the money bankers pocketed. But it is the realisation that bankers collectively failed to protect their own capital, depositors' and investors' money in their rat race for booking pseudo profits that has unleashed public anger.

It is a matter of common knowledge now that managements and the boards of leading global banks failed in their fiduciary duties to protect the interests of depositors, investors and shareholders in the events that led to the financial crisis. At a macro level, they failed the economies and the financial systems by causing huge disruptions in fund flows. If a big bonus is the reward for success, it is but natural to ask why the taxpayer should underwrite bankers' failures.

Lack of fairness

Critics decry the bonus system for its lack of fairness and its contribution to widening inequality. But the greater problem with such a payout is that it provides an incentive to take risks and in many cases hide it.

Following the financial crisis which was largely blamed on the faulty incentive structures of banks that encouraged excessive risk-taking, there have been attempts to curb large payouts. The experience shows there needs to be a wider global agreement on bankers' pay that could limit excessive risk taking.

The Volcker Rule in the US (part of the Dodd-Frank Act) seeks to ban proprietary trading, a huge source of performance-linked bonuses for bankers. When the traders get lucky, they get the short-term upside. When things go bad, the losses are handed to the government through various forms of downside protection.

Paul Volcker, a former Federal Reserve chairman and the author of the Volcker Rule, believes that a prohibition of short-term trading mentality of banks will automatically bring down banking sector incentives. Speaking at a conference in Abu Dhabi recently, Volcker said, "Banking regulations need to be geared up to rein in incentive structures that encourage excessive risk-taking."

Restraining payouts

While the Volcker Rule tries to tackle the incentive structures at their root, across the Atlantic regulators are clearly moving in the direction of restraining bonus payouts. Last week the Bank of England urged UK banks to use any spare cash to bolster their balance sheets rather than splurging it on bonuses. European Union lawmakers have gone to the extreme of proposing a curb on the variable component of bankers' pay to a maximum of two times the fixed component. The EU is also considering a limit on the gap between lenders' highest and lowest salaries, as part of an overhaul of financial regulation later this year.

Clearly bankers seem to get no sympathy from any quarter. Seemingly the fundamentals of the market economy itself are not likely to come to their aid, after all laissez-faire has not sanctioned the asymmetric profiteering from short-term trading on one hand and passing on the losses to the taxpayers on the other.