European bank bonuses show little break with the past

Here comes more evidence that self-regulation and asking nicely doesn’t work. New “guidelines” on bank bonuses and pay structure in Europe came out in December 2010, but a recent survey from the European Banking Authority shows us that not much has changed.

The EBA was created on January 1, 2011 as a replacement for CEBS, the Committee for European Banking Supervisors. The CEBS came up with the payment guidelines right before it disbanded. Unfortunately, its parting shot was too week. As the EBA writes, the guidelines included “numerous open aspects where judgment by institutions and by supervisors is required.” Surprise: some institutions have decided to drive a Mack truck through the holes in these “open aspects”.

To be fair the guidelines have some tricky aspects. For example, in a perfect world bonuses would only be given when the firm performed well overall and when the employee’s own work led to good outcomes in the long term, not just in the short term. They wouldn’t be given all at once, but would be dribbled out over time so that his or her long term impact could be assessed. Suppose that despite this safeguard the company finds that a trade made years ago was actually a dog in waiting. And that the bonus it gave out was actually not deserved. Could the firm take it back?

This is known as a clawback and it can be difficult to do, for it would mean mean seizing the employee’s own property. As law firm Freshfields Bruckhaus Deringer describes, this does not sit easily with the labor laws that exist in many European countries. So it makes sense that this aspect of the new guidelines has not been fully unpacked by the various countries.

But what about something as simple as identifying who the risk takers are in each firm? The pay guidelines called for financial institutions to make an inventory of the employees who are most responsible for the collective risk taken by the organization. The guidelines will then apply only to these “Identified Staff” members. Traders, portfolio managers, the treasurer, CFO and CEO — these are just some of the functions that should be on an honest list. In fact, for a large institution with several thousand employees one would expect the number of people on the list to hit the triple digits. Yet the EBA found a “clear tendency” of institutions to low-ball this figure, which tells you all you need to know about their determination to not be hindered by these pesky guidelines:

Institutions tend to identify lower numbers of Identified Staff, especially the bigger institutions. In the view of supervisors this is inadequate for effective risk management.

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Although one would expect investment banks consistently to have a higher percentage of Identified Staff than retail banks due to the higher risk profile, this is not the case in practice.

Even more damning is the survey’s findings that bonuses and other forms of variable compensation still dominate overall pay, in some cases by as much as 940%. This is astounding. If people tend to behave the way that you pay them — and they do — then this is a great way to encourage the kind of risks that led to financial crisis and bank bailouts.

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Tags: bonus, bonuses, clawbacks, compensation, EBA, European Banking Authority

Category: Bonus culture