Regulatory gaps let banks off the bonus hook

September 6, 2010

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

By Peter Thal Larsen

Investment banks have reined in their worst pay excesses. But inconsistent enforcement of bonus rules in the United States and Europe means some are still getting away with bad behaviour. If banks and regulators can’t agree common standards, they risk another political backlash.

It’s almost 18 months since the world’s regulators agreed a common set of principles for bank pay. But the interpretation of those standards has been far from consistent. While the U.S. Federal Reserve has issued the institutions it regulates with broad guidelines, the European Union has passed a detailed directive, including a requirement that a proportion of any bonus should be paid in the form of contingent capital. Add in one-off levies like the UK bank payroll tax, and it’s not hard to see why banks are struggling for a common approach.

Investment banks have cleaned up their act to some extent. Most bonuses now include some deferred payment, often in the form of stock. This aligns bankers’ incentives with those of shareholders, and discourages them from taking short-term risks that may blow up in a year or two. Multi-year guaranteed bonuses have almost entirely disappeared.

However, there are plenty of signs that some banks are still ignoring the spirit of the new rules. Some banks apparently circumvented the ban on multi-year guarantees by offering prospective employees loans which would be forgiven if they stayed for several years. Others have allowed bankers to borrow against deferred stock awards. Even if these practices are not widespread, they put pressure on other institutions to follow suit.

Meanwhile, the lack of consistency makes it hard for banks to show restraint. Take Credit Suisse, which responded to the UK tax by cutting bonuses for London-based managing directors. But its rivals failed to follow its lead, and the bank is now planning to give those same MD’s a special September payout.As long as investment banks remain highly profitable, the bonuses they pay their staff will be an ongoing source of public anger.

New regulations on bank capital and liquidity should eventually lower the industry’s returns, which in turn should squeeze the bonus pool. In the meantime, however, regulators and bankers have every incentive to take a common line on restraint. If they do not, they risk a further — and more far-reaching — political backlash.

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