There are alternatives ….
There seems to be an increasing number of politicians calling for a cap on bankers’ bonuses, is this because they believe it will ensure a more effective banking system for the British economy, or is this considered a popular statement to get votes?
Clearly it is in the UK’s interests for the banks to operate in a way that we do not have a repeat of the credit crunch, but a cap on bonuses is not the solution. Bonuses must be based on performance, if a banker performs well they should be rewarded appropriately, simply applying a cap on bonuses will put a cap on performance.
Whilst some degree of regulation could help to ensure that bonuses reflect longer term (sustainable) performance an alternative approach is to make the consequences of bank failure high, very high.
Right now we have a clear example. The UK has invested huge amounts of taxpayer revenues into the banks. What would hurt the banks is if the shares are sold back at the maximum profit the UK tax payer can make. Most banks are going to recover and will increasingly start to report large profits again, as a result their share prices will start to rise. If the UK Government sells back those shares at only a small premium to what was paid for them then the banks have effectively been given a low interest loan! (which is a bit ironic in that they are not providing cheap mortgages). Alternatively if the UK Government holds onto those shares to benefit from selling at a significantly higher share price, then the cost to the banks will be much higher.
Another example. Regulation could be established such that any bank deemed to have fallen into a category where there is a high risk of failure then penalties can be applied by selling part of the bank’s shares to the Government at a massively reduced price e.g. 10% of value. The cash received would restore the bank to a safe operating level, but the penalty paid by shareholders would be high, and the risk to shareholders would drive much safer bank operating practices.
Cleary the examples above are simplistic, but the underlying strategy is compelling, make the price of failure for banks high enough such that they will avoid failure. We must avoid a solution that caps banks performance to create middle of the road businesses that do not help to grow the UK economy.
