FT editorial: Bonus cap is a bad omen for Britain

18 February 2013

Voters still angry at banks may applaud the EP's push to cap bankers' bonuses. But it is a defeat for common sense and for Britain, whose banking sector is in the line of fire.

The crisis has proved beyond doubt that bank management does not always know best when it comes to remuneration. But politicians are poor substitutes for the market. Of course, taxpayers have a stake in the incentives bankers enjoy because banks have all too often been bailed out. There is a need for much tighter rules on banks’ capital adequacy, liquidity cushions, risk-taking, and – yes – the incentives that are part of remuneration. On the whole, the fourth update of the Capital Requirements Directive, now nearing the agreement needed between the parliament and national governments to make it law, serves this goal. The bonus cap, which the parliament inserted into the CRD4 on its own initiative, does not. If extended to private equity and hedge funds, as some are contemplating, the effect will be far worse. 

A cap on the ratio of variable to fixed pay will do little to lower total compensation (which is what outrages voters sick of bailing out failed banks); it will just encourage higher fixed salaries to compensate for the lack of bonuses that tend to be far larger. That removes a tool for managers to control risks: surely the opposite of what is needed.

The parliamentarians’ pet idea is a result of populism mixed with ignorance of how banking works. The proposed law casts an equally unflattering light on the governments lined up behind it. France and Germany both now support the proposal. They know well the harm it will cause. That the harm may fall predominantly on the City of London’s model of banking is a victory for the two countries’ conceit that the crisis was a pathology of “Anglo-Saxon” finance and for their efforts to exonerate their own banking models from criticism.

A last-minute push by the UK to improve the current draft law may be successful: it would exclude certain longer-term bonus payments linked to performance and subject to clawback from the cap; European banks’ affiliates outside Europe would also face lighter rules so they remain competitive. But the UK failed to stop things from going this far, which means that the basic principle of a bonus-to-salary ratio has largely been conceded. That is a sign of Britain’s limited power to block EU developments in a strategic sector. 

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