EU bonus assault would lead banks astray

April 16, 2012

By Chris Hughes

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Europe’s urge to set a bonus-to-salary ratio has always looked misguided. Yet Brussels’ position is hardening. The latest thinking seems to be that bonuses should never be more than 100 percent of base pay. There’s no doubt that investment banking still has a problem with the way it rewards staff. But fixing bonuses in this way is clearly the wrong solution.

Doubtless, a political desire to bring down overall pay levels lies behind the moves. But it is naïve to think that a 1:1 ratio will achieve this. Banks would respond by jacking up base salaries – as they have done already, following pay curbs introduced in the wake of the financial crisis. Moreover, higher salaries mean higher fixed costs. That reduction in flexibility would be stifling in an industry as cyclical as banking. Pay is banks’ single biggest operating expense.

It is rarely wise to force any sector to pay staff in a uniform way. Higher operating costs won’t help banks rebuild capital faster. Implementation would be chaotic if changes were imposed overnight. There would also be distortions: the rules would apply to European Union-domiciled banks globally, but only to the EU-branches of non-EU firms. Either way, the City of London would be hit hard. An outright cap on pay might even be anti-competitive.

Given these manifest snags, why has the industry has been so ineffective in killing the idea? Because it hasn’t come up with an alternative. Worse, many banks have persisted in making provocative pay awards, while national regulators have been inconsistent in applying existing bonus reforms.

It is an absurd situation. Europe is urgently demanding that some member states foster flexible labour markets, while a growing faction within the European Commission and European Parliament want the opposite in financial services. Meanwhile, the fundamental problems surrounding pay go unaddressed: weak competition fuels excess profits and, in turn, excess rewards; the division of profits between staff and shareholders is unbalanced and may be unfair.

Banks are running out of time to show a better way forward.

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