Cheques and balances

Banks, by acting as agents of wealth destruction in the global financial crisis, have lost their absolute right to decide the bonus payments of bankers, certainly in Ireland and increasingly elsewhere. Last week, the European Parliament voted to cap bank bonuses at no more than twice annual salary. And on Sunday, Switzerland went even further. Over two-thirds of its voters in a referendum agreed to cap not only the pay and bonuses of its bankers, but also those of the country’s top company executives. This move towards greater regulation of banks is long overdue, and welcome. It reflects a widespread concern of governments worldwide – and of their many angry citizens – at the huge price paid for the failure of the banking sector.

Banks and bankers who engaged in reckless lending have suffered less than the taxpayers who rescued them, who have paid excessively for the financial follies of the banks. Banks’ gains were privatised, while their losses were socialised. Certainly, their reckless lending has crippled the domestic economy. It has cut the real income of taxpayers, wiped out bank shareholders, and almost bankrupted the State. Banks took on excessive risk and large bonuses based on short–term performance were paid for what became illusory gains.

To learn from one’s mistakes is one way of ensuring they are not repeated. The bias in bank lending that favoured excessive risk-taking to boost short-term performance, and to increase bank profits, was always a flawed model in a bubble economy. Undoubtedly, financial incentives are necessary both to encourage individual initiative and reward success. However, a maximum 200 per cent bonus based on salary should serve both to discourage excessive risk-taking, while providing adequate compensation for good performance by bankers.

Not surprisingly, those most opposed to this reform in banking regulation – the UK government and the City of London – fear that Britain’s financial services industry has most to lose from the proposed change. They also see this as an attempt by the EU to set pay in the City of London, and so weaken both its position as Europe’s financial centre, and financial services as the UK’s most valuable industry. Yet again, it places the British government at odds with the EU, exercising less and less influence as the UK remains outside the euro zone and outside the proposed banking union.

Whether the cap will see banks and bankers leave London to relocate in New York or Singapore is doubtful. Certainly, the British public are less likely than their government to oppose the EU moves, which partly redress the massive imbalance that exists between the banks and the ultimate lender of last resort in a banking crisis, the taxpayer – to whom no bonus is awarded.