Wednesday, April 25, 2012

Real issue for banker bonuses is not how large or when paid, but are they merited based on risk taken

The Bank of England's Andrew Haldane has once again focused attention on bankers bonuses with his call to defer payment and increase the claw-back period of these bonuses to 10 years.  This increase to 10 years is an attempt to end a mismatch between end of year bonuses and multi-year risks.

In making this proposal, Mr. Haldane shows that the real issue for banker bonuses is 'are they merited given the risk that was taken to earn them'.

Regular readers know that your humble blogger does not think that regulators should involve themselves in the mechanics of banker bonus payments.  The mechanics should be related to each firm's business strategy and are more appropriately set by the Board of Directors and approved by the shareholders.

I prefer that the regulators focus instead on making sure that both the Board of Directors and the shareholders have access to the information that is necessary to independently confirm that the bonus was merited given the risk that was taken to earn them.

The foundation for this is requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

According to a Telegraph article,

Andrew Haldane, executive director for financial stability and a member of the Financial Policy Committee, said "while bank performance has fallen off a cliff, executive pay remains close to pre-crisis Himalayan heights". 
He argued in a speech given in Berlin that bonus deferral, or claw-back periods, should be extended to 10 years or more on an internationally co-ordinated basis, from three or four years at present, to make bankers responsible and accountable for their decisions for longer. 
"The risk cycle might last perhaps 20 years. This duration mismatch means it is more likely than not that risk and reward may get out of kilter in the financial sector," he said...
He said the way bankers were paid should be reconsidered, broadening the instruments used beyond cash and shares. 
"The focus to date has been on non-cash distributions, often in equity. But paying in equity appears in some pre-crisis cases to have exacerbated risk-taking incentives, acting as a disincentive to raising new equity and encouraging gambles for resurrection," he said.

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