Share the pain

Stock-based bank pay one reform China doesn't need

How to incentivise bankers is a topic China has pondered for centuries. Some Qing dynasty lenders used to keep executives in line by threatening to enslave their families. In the 1980s, many state-owned enterprise chiefs made up-front security deposits to guarantee good behaviour. A new proposal to pay executives in stock - encouraged by Bank of Communications on August 21 - sounds like progress. Really, it's little better than what came before.

Bank bosses in China are paid a pittance compared with their Western counterparts. BoCom's chairman, Niu Ximing, took home 1.8 million yuan ($290,000) in 2013. Stuart Gulliver, who runs BoCom's 19 percent shareholder HSBC, got the equivalent of 82 million yuan. For many Chinese bankers, the rewards of the job are non-financial, like political favour. Central bank chief Zhou Xiaochuan and securities regulator Xiao Gang both did stints at state lenders before being promoted to their current jobs.

Paying in shares, which the Ministry of Finance banned in 2008, might make executives more focused on the bottom line. But the shortcomings of share-based compensation are magnified in China. Those receiving stock need to believe they can drive up the share price by doing a better job. Yet Chinese bank shares have flagged in recent years even though lenders consistently report returns on equity around 20 percent. The state, as majority shareholder in the biggest lenders, is among the losers.

Given a free hand, bank bosses might be able to boost valuations by owning up to bad debts hiding on the balance sheet. Most Chinese lenders trade below their published net asset value, according to estimates by Barclays, largely because investors don't believe what they read. A profit-motivated bank chief might also eschew lending to state-owned enterprises at low interest rates in favour of riskier but higher-paying private borrowers. Since the state views Chinese lenders primarily as a tool of macro-economic policy, that kind of strategic freedom seems far away.

Once bigger reforms have been ushered in - like removing bureaucrats from executive boards, and binning effective loan quotas - stock-based pay might be more useful. But as long as share ownership and control remain separate, the risk is that banks end up with the worst of both worlds: dysfunctional structures and glum managers.