Bonus capping – ruin or re-birth for the state-backed banks?

Barclays and HSBC posted upbeat results today and the question everyone wants to know is, “Does this mean the recession is over?”

No, stuff that! The question everyone really wants to know is whether or not they will be paying bonuses, bankers remuneration having joined paedophilia and X-factor as a national obsession. Both banks are understandably being cagey about how much they will pay out. They are making the right noises about sticking to the G20 guidelines but, even so, they will almost certainly be rewarding their staff more handsomely than Lloyds and RBS have been able to. With foreign banks in the City also starting to pay bonuses again, does this mean that there will be a mass exodus from the bonus-capped state-rescued banks?

In the wake of the bonus cap, City headhunters claimed to have been inundated with CVs from bankers at RBS.  That, in itself, is a sign of the times.  In the good old days, before 2007, you didn’t contact headhunters, you waited for them to contact you. Only the desperate sent out unsolicited CVs. If you were getting fed up at work, the chances were that the headhunters would know about it even before you did and would call you up to tell you that you needed to look for another job. There was a time when they would have been all over a stricken firm like RBS, cherry-picking the key talent. Not now though, it seems.

So is the bonus cap really a stick that their rivals can use to beat the state-backed banks? Will Lloyds and RBS be stripped of their key talent?

No-one really knows because no-one has ever dared to challenge the City’s bonus culture until now. The assumption for the last twenty years has been that if you broke ranks and refused to pay huge bonuses you would just lose all your staff and your profits would collapse.

As City boy Andrew Clavell said two years ago:

One might as well howl at the moon as clamour for changes in compensation structures.

If one firm broke ranks on compensation structures, its employees will vapourise, starting with the best, and the firm will be destroyed. And good luck recruiting at Harvard or INSEAD next year too.

When I worked in comp and ben in the City, over a decade ago, a few people used to mutter that the reward merry-go-round could not go on forever. But, of course, it did, largely fuelled by the complex financial instruments and cheap money from China that eventually tipped the financial system over the edge. As long as profits continued to rise, the shareholders were happy and no-one wanted to rock the boat.

Many of us used to wonder, albeit quietly, whether some of the so-called stars were really worth the money. After all, the way reward is determined in the City isn’t just about pure numbers. A lot of lobbying and politicking goes on too, which is why it is so difficult to get anything done in an investment bank at this time of year. The same is true of the massive bonus hikes that come when staff are poached by one bank from another. Yes, they are usually capable people but often the amounts paid to them are as much a function of the acquiring boss’s ego as the team’s profit generating potential. People in the City like to get one over on each other and if that means paying a large amount of money to coax a team away from a rival then so be it. In short, the link between pay and financial performance in the City is not as direct as some would have you believe. Like everywhere else, politics, power, pride and prejudice muddy the waters.

So what would happen if a bank decided that it could get better returns by paying lower salaries for people who were not quite stars, or not arrogant enough to claim to be stars? I have heard it argued more than once that, even if you didn’t pay top-dollar, salaries would still be high enough to attract a steady stream of bright young things who could be trained up to do many of the jobs in investment banking relatively quickly. OK, they might not be as good as your experienced staff but, so the argument went, if you got eighty percent of the performance for sixty percent of the remuneration, you’d be laughing. Furthermore, it might be that even your existing ‘stars’ are not as much in demand from your competitors as they would have you believe. What if you called their bluff and refused to pay them the extra bonuses they were demanding? You’d soon find out if they really did have a queue of competitors waiting to take them on.

Of course, no-one ever dared to try any of this out. Until now, that is.

The government’s capping of bonuses at RBS and Lloyds will put the myths around banking remuneration to the test. If the claims of the investment bankers were right all along then Lloyds and RBS will suffer an exodus of staff and a massive drop in profits as a result. But if, on the other hand, high City bonuses were simply the result of banker collusion and self-justifying hubris, then the state-backed banks may yet be able to make healthy profits without shelling out the rewards that were previously thought to be essential. Bonus capping is, indeed, an interesting and bold experiment.

Not that the government is being bold, of course. It only capped bonuses for the same reason as it does many other things; as a knee jerk response to a public outcry. The government is not sure whether to run Lloyds and RBS in the public interest, as nationalised banks, or simply as a shareholder looking for a commercial reward and a medium-term profit. Its policy on bonuses has arisen from this confusion, rather than from any systematic attempt to change the culture in the City. 

But, even though no-one is saying so, bonus capping is a risk. If bonuses really are crucial to the success of banks, the policy may yet damage the taxpayer’s investment, as the key assets of RBS and Lloyds are headhunted away. However, if they pull off a return to profit despite the reduced rewards for their staff, they may yet explode some of the myths around the bonus culture.

Only time will tell but I wouldn’t want to bet my house on the outcome.

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2 Responses to Bonus capping – ruin or re-birth for the state-backed banks?

  1. mkeeffer says:

    Your post reminds me of a conversation I had with a friend’s dad – he was a Stanford MBA consultant and a top leader at Stanford Research Institute. He’d worked with CEOs across the U.S. I asked him if high-level executive management was like a membership in an exclusive club. He said yes – and that too many CEOs weren’t competent and should have been held to higher standards of performance.

    I’d say were now seeing that in UK and US banks. The performance in no way justifies the pay. Cut the pay and bonuses. Competent second-string players will take the positions and possibly do far better than those who have been looting.

  2. Wolfie says:

    I have to agree. Over 15 years in banking I’ve seen the remunerations go from obscene to stratospheric. I would however remind readers that the highest bonus’ are invisible to most people in the hedge funds and other more shady institutions. Greed is now worshiped.

    Unfashionable a view as it may be I’ve also watched the old school posh boys disappear over the years to be replaced by hungry and single-minded hoodlums. They have a different view of risk and I think the banks have paid a dear price for this social revolution in the end. Along with everyone else.

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