No one outside the banking industry itself – precious few inside it even – can stomach how much investment bankers and traders get paid. It’s the topic that simply won’t go away. Credit Suisse has made a bigger effort than most to incorporate all the latest best practice principles on pay – linking it to the bank’s medium-term return on equity, ensuring payouts are deferred and subject to claw-back if divisions turn loss-making.
But no one outside the industry cares about this stuff. They don’t care about the percentage of revenues that banks accrue for comp each quarter. It’s the absolute numbers that provoke disgust, outrage and disbelief. All three emotions were predictably vented last month when news broke that Credit Suisse had granted big cash bonuses to London-based staff whose pay had been cut by the UK government’s windfall tax on their bonuses in April.
It’s worth asking just how far this outrage and disgust with pay, stoked by politicians keen to pin all the blame for unemployment on the banks and encouraged by central bankers and regulators eager to deflect attention from their own failures, drives the process of banking re-regulation.
Bankers see almost every proposed regulation as a drag on profits and returns, taking the industry to the point where it might no longer be able to promise a return on equity above its cost of equity.
Do policymakers want to make banking less profitable so as to reduce bankers’ pay?
Certainly banks might want to build capital first and pay earnings out as bonuses or dividends second. But here’s the thing. It was in both mature and developing economies – think of Australia, Hong Kong, Canada – where basic banking was solidly profitable that the financial systems remained most stable. Banks didn’t chase returns from CDO squareds, because they didn’t have to. They made enough on charging for balance-sheet loans, checking accounts and money transfers. There’s a strong argument that only by boosting banks’ ability to profit from core banking will the temptation to chase returns in uncontrolled ways be curtailed.
If politicians and regulators really want to cut bankers’ pay by cutting banks’ profits, they might do well to consider simpler ways of achieving this than by imposing excessive new capital ratios, cumbersome recalibrations of risk-weighted assets and misguided liquidity requirements. These all risk disrupting capital formation and credit availability.
Let’s take a look at the accounting instead.
And let’s also be clear: bankers have indeed paid themselves outrageously. The most galling aspect of bankers’ pay is that so much of it is granted on unrealized profit. Fair-value accounting allowed banks to report ludicrous so-called profits and returns on equity based on upward revaluation of assets driven by indiscriminate provision of leverage. It didn’t matter, in the run-up to the global financial crisis, that banks hadn’t realized any cash profits by selling securities. Marks went up. These were booked through the P&L. Traders held out their hands for bonuses. The system moved from originate to distribute to originate, re-leverage and hold. Reported profit was a fiction. The 25% and 30% returns on equity were not real.
When the system broke, asset values fell so far and so fast that banks had to be bailed out to avoid a catastrophic unwinding. Traders didn’t have to hand back any of the pay they had taken.
In recent months, credit markets have improved; problem assets are recovering, going back up in value. Revaluations and reserve releases are boosting apparent profits. Traders are getting paid again, in some cases on assets that they have already taken one fortune for as they went up the first time.
This isn’t very sensible. It beggars belief among banks’ customers. Manufacturing industries don’t pay big bonuses to their staff because the theoretical value of their inventory has been marked up. They pay staff for making widgets and selling them.
Would it not be better to mark revaluations of assets and liabilities on banks’ balance sheets, without running them through the profit and loss account?
The notion that credit should be a liquid, traded asset class pervaded the entire financial industry in the past 15 to 20 years. It led to the creation of a credit default swap market many times the size of underlying actual credit. CDS spreads became a proxy for experienced credit officers pricing actual loans.
There is precious little evidence that this led either to a more efficient allocation of credit or to any social good. In fact, the evidence before us suggests it achieved the exact opposite. Yet earlier this year the US Federal Accounting Standards Board proposed extending requirements for banks to adopt so-called fair value, or market-based valuation of banking book loan assets, all in the name of greater transparency.
It seems we’re heading in the wrong direction on accounting. Is there any other way to cut bankers’ pay without so curtailing bank’s profits that they cannot perform their useful social functions of money safekeeping, transfer, investment and credit formation?
One banker suggests the only way is to follow the laws of supply and demand and re-orient education systems to churn out so many investment bankers that over-supply drives down their pay.
Of all the suggestions Euromoney has heard, this is probably the most horrible.
