Three Problems With G20's Promise to Curb Bankers' Bonuses

Last Updated Apr 3, 2009 8:46 AM EDT

Bankers have become the social pariahs of this generation. We have our poster boy, with Fred the Shred (apparently now considering a voluntary pension cut). We have had the villagers with pitchforks converging on London's financial sector; and we have the G20 weighing in with plans to control the bonuses of banking executives.

On one hand, it's no great shock the government is adding its voice
to the clamour. On the other hand, there's something alarming about the nature of this intervention.

At the close of the London Summit, the G20 announced unprecedented restrictions to bonuses received by bankers, forcing them to link compensation to the risks they are taking over the long term, and restrict or cut bonuses in the event of poor performance by the individual or the firm further down the line.

The rules -- if applied -- should mean senior bankers will get a small fraction of bonuses in cash, and most of it will be deferred and in shares.

Much of this doesn't come as a huge surprise. It follows a barrel-load of government rhetoric about producing a code on bonus structures.

It also comes after more draconian measures in the US, where executives at state-backed banks have their salaries capped at US$500,000 (£343,000); and Ireland, where executives at banks underwritten by a state guarantee had salaries capped at 500,000 euros (£456,250).

The new rules seem reasonable, and follow patterns already established by a number of banks in recent months.

The problem is that this is now becoming mandatory, and governments are to take on the role of internal business compensation.

I see three problems with the announcement.

  1. If it means a drop in compensation, it's going to hurt the already precarious position of government finances, which will face a drop in revenues from income tax and national insurance (12 per cent of which come from the financial sector).
  2. If the schemes are too punitive, it could damage the recovery prospects of the banks themselves, as the best talent will simply leave. As this is a worldwide co-ordinated effort against bankers, the quality professionals will flood out of the industry entirely, and an already beleaguered sector will be left with the mediocre and the incompetent.
  3. Perhaps most important, this is a frightening level of intervention. The last time where the government reached into businesses and tried to control reward was with the wage restraints of the 1970s, and this could herald a new era when the government feels it has a role in micro-managing business.This stops organisations being able to decide for themselves the appropriate reward to attract the talent that is required.This sort of legislation also fails spectacularly to achieve what it intends. It simply focuses the minds of pay professionals on the most ingenious way to get around the legislation.
The end result may go some way to quelling the angry mobs determined to see the banking sector pay for its mistakes, but it sets a worrying precedent.

The question is how far world leaders are prepared to start tinkering with the inner workings of business in this climate, and what's next?

More mixed G20 reactions:
"Frankly, they could all have stayed at home and Skyped each other." Dr Eamonn Butler at Adam Smith.
"A turning point? No. But...most bigt-ime international meetings produce nothing. This did something significant." Paul Krugman
No surprises, but the reforms "represent the death knell for the Anglo-American Doctrine that economies flourish when financial firms are left alone to do as they please." Robert Peston
"For now we watch this G20 fritter away its energies on side-shows, or bread and circuses for the mobs." Ambrose Evans-Pritchard.
(Picture: Room1834, CC2.0)