Some seven years after the banking crash and the public concern about excessive financial rewards for failure in the financial sector that came as a result, the Bank of England has finally announced proposals for reigning-in executive pay. The key proposal in the government consultation paper is that the payment of bonuses could be deferred for 3-5 years. In the event of misconduct or conduct failings, bonuses could be clawed back 5-7 years after they are first awarded.
The proposals may soothe public anxieties, but there are a number of issues.
1. The banking crash has revealed a rotten banking culture where banks indulged in money laundering, sanction-busting, interest rate rigging, tax avoidance and outright fraud. Such practices enabled banks to meet profit targets and maximise performance related pay of their executives. No executive has been prosecuted even though billions have been spent to bailout banks. Now none will face any retribution because the clawback rules will only apply to bonuses declared after 1st January 2015. So they have got away scot free.
2. The proposals do not check excessive executive remuneration. Company executives sitting on each other’s remuneration committee will continue to set the benchmark. The consultation paper assumes that shareholders will check align risk and rewards even though shareholders did not check reckless conduct culminating in the banking crash. Their interests and short-term and they do not bear residual risks as taxpayers continue to bailout banks. The typical duration of shareholding in a bank is around 3 months. Shareholders provide only a small fraction of bank capital. For example, the 2013 balance sheet of Barclays Bank shows total assets of £1.312 trillion and a capital of only £63.95 billion, i.e. shareholders provide less than 5% of total capital. The Parliamentary Commission on Banking Standards concluded that “shareholders failed to control risk-taking in banks, and indeed were criticising some for excessive conservatism”. So any proposals that rely on shareholder activism will fail. Interestingly, there are no penalties on shareholders for exerting pressure on directors to take excessive risks.
3. After the 2007-08 crash, the Financial Services Authority (FSA) has been replaced by the Prudential Regulation Authority (PRS) and the Financial Conduct Authority (FCA), but these structures continue to be dominated by financial grandees. Historically, they have shown little appetitive for curbing abuses in the financial sector. After a stint as a regulator, they often return to lucrative positions in the private sector. They know that tough regulatory action by them would severely constrain possibilities of a bumper pay day. There is little reason for believing that the new regulatory structures will deliver robust regulation, especially as there is little openness and accountability of the conduct of PRA and FCA.
4. The ultimate cost of the banking failures is borne by taxpayers, savers and borrowers. However, these stakeholders have little representation on the PRA and the FCA. Thus, there is no public mechanism for ensuring that the interests of stakeholders are given due weight in identifying misconduct.
5. Misconduct or conducts failings are the trigger for clawback, but how will regulators become aware of misconduct? All banks boasted ethics committees, audit committees and internal audit departments, but none ever blew the whistle on their predatory practices. External auditors gave a clean bill of health to all distressed banks, all for a fee. Even worse, some colluded with the banks to enable them to massage their accounts. So what exactly is the mechanism for identifying conduct failings?
6. The allegations of misconduct will be contested and the outcome may not be known for years. Any arbitrary limit on the period of clawback, e.g. 7 years, will enable some to escape retribution merely because the legal processes are time consuming.
7. Even if bonuses are clawed back there is still the concern that market pressures that require banks to increase profits, or social pressures which judge the worth of a person by financial rewards will continue unabated. So the structural pressures for misconduct are not addressed.
8. The implementation of the proposals will lead to creative games. For example, as the deferral and clawback provisions only apply to bonuses, executives may award themselves higher fixed pay and thus reduce the amounts that become subject to deferral and clawback. The employment contracts of key individuals could be held by subsidiaries in tax havens and thus moved beyond the jurisdiction of regulators. The consultation paper does not consider such possibilities.
The Bank of England is making the right noises, but without a fundamental reform of the way banks are governed there is little chance that the proposals will have the desired effect.
A fundamental overhaul of the system of governance would include a Stakeholder Board to guide and monitor the PRA and the FCA. Thus, the grandees can’t bury bad news. All executive remuneration contracts need to be publicly available. Employees, savers and borrowers need to elect bank directors and vote on their remuneration. This would prevent telephone number remuneration packages from becoming the norm. Regulators themselves need to conduct real-time audits and that means having monitors at every major bank branch. Without this there is little chance of identifying misconduct on a timely basis and taking effective action to curb malpractices.
Crossposted with thanks to CLASS.