Dunce's cap

EU bonus crackdown means more cash for bankers

If Europe wants to hard wire excess pay for bankers, it is going the right way about it. Proposals to set a maximum ratio of bonuses to salary are so manifestly counterproductive that it’s hard to believe they have gained almost unstoppable momentum among European Union members. Bad policy is what happens when weak management in the financial industry collides with the politics of envy.

Investment bankers are overpaid. The rewards in banking are still way beyond those available in other industries. This is partly because investment banking is an oligopoly: a handful of big global firms control the pathways of international finance. It’s also because the business enjoys an indirect taxpayer subsidy in the form of bailouts when things go wrong. And, in some parts of finance — notably advising on deals — clients will pay top whack to have the very best person on their side.

But capping bonuses is not the answer. It would make matters worse. Such a policy would cause further inflation in base salaries — a phenomenon already under way following post-crisis curbs on cash bonuses. And, cutting handouts relative to base pay means there would be less deferred compensation to be clawed back in future if trades blow up or bad behaviour is discovered.

Fixing the problem of excess pay requires lowering banks’ excess returns. After paying their employees, banks’ main expense is servicing equity capital, the cushion against losses provided by shareholders. If banks hold more capital, the cost of providing investors with a decent return would leave less to distribute as bonuses. This process has already started, though shareholders need to be more muscular. So-called living wills, which should make it possible for banks to fail safely, will help remove the taxpayer subsidy. Where competition is weak, governments should legislate to increase it - or impose higher taxes.

Britain is lobbying hard against the EU’s proposals. Unfortunately, perceived self-interest in protecting the City of London, twinned with the prevailing scepticism about the UK in the rest of Europe, render it a weak advocate. Banks have also singularly failed to make a credible counter proposal. The result will be precisely the opposite of what was intended — more cash for bankers.