Europe leads the way on reforming the bank bonus culture

By Arlene McCarthy MEP

The European Parliament in Strasbourg this week voted to back a crucial first reading deal on new laws to end the risk-taking culture in banking that led to the global economic crisis.

Financial experts all agree that a high risk, short term bonus culture combined with a lack of capital were central elements in the 2008 global financial crisis. Governments and taxpayers ended up bailing out the banking sector across the EU, with an injection of some 3.9 Trillion Euros of support.

In the United Kingdom circa £1.2 Trillion of support was extended to the banking sector, almost equivalent to the UK’s annual GDP. Savers and investors saw the value of their pensions and investments decline as a result of the banks’ risky practices. The bankers walked away with the short term profits from these risky practices while the risks they took will remain on banks’ books for years to come.

We are constantly told by the banks that they have learned the lessons of the crisis.

If that is the case why did the Bank of England Financial Stability Report state in June that the proportion of bank revenues allocated to salaries and bonus has actually increased since the banking crisis?

The extra 10 Billion Pounds paid out by UK banks in salaries and bonuses represents 10 Billion pounds that could have been put towards banks’ capital, and therefore supported, as the Bank of England makes clear, around 50 Billion Pounds of additional lending to small businesses and families.

Furthermore, Bank of England reports show lending to small and medium sized enterprises in the UK has actually declined in recent months, and that mortgage lending is expected to contract in the next few months.

We have a duty as legislators to respond to public concern. I am pleased the European Parliament has backed my tough reforms to end the obscene bonus culture. At a time when the government is making substantial cuts, scaling back public services and support to families and businesses, our constituents expect banks to prioritise stability and lending over their own pay and perks.

The deal which I negotiated as Vice Chair of the Economic and Monetary Affairs Committee was reached in a series of talks between the European Parliament, Council and Commission. The good news is that the new law on bankers’ bonuses will be implemented for the upcoming 2014 bonus season.

It will force banks to hold more capital against riskier activities on the trading book and against re-securitisations, such as those re-packaged mortgage backed securities which were a key cause of the financial crisis.

The law also forces banks to reform their remuneration and bonus practices, with rules that break the link between financial reward and excessive risk taking. The effect of Parliament’s amendments is also to ensure remuneration policies first and foremost prioritise the health and stability of a financial institution and lending to the real economy.

Parliament has insisted on a tough interpretation of the internationally agreed G20 principles to ensure that the upfront, cash proportion of a bonus is strictly limited. Paying a large part of a bonus in cash, without any deferral or assessment of actual performance, leaves an unacceptable incentive for taking dangerous short term risks. The law will ensure that the upfront cash portion of any bonus is limited to 30% of the total, and at most 20% for large bonuses.

The robust rules on remuneration also include:

* Deferral in line with the business cycle, with annual review and clawback

* Tough measures for bailed out banks

* A cap on the ratio of bonus to fixed salary

* Payment in contingent capital alongside shares

* Increased transparency, accountability and improved corporate governance

* Coverage of “Bonus-like” pensions – so a banker responsible for the collapse of a bank will no longer be able to walk away with a 16 million pound pension pot.

This new law, amending the capital requirements directive, addresses those fundamental flaws and weaknesses in the banking system, which led to the crisis.

The banks have had two years since the 2008 financial crisis to do this and have failed to act, so now we will do the job for them.