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New bonus rules may make bankers happier campers

The news was taken badly by some bankers. thehutch, CC BY

Imagine having to wait seven years before you could be sure that what you were properly paid for your job. If it sounds like a bad deal then maybe it’s time to spare some empathy for bankers at UK financial institutions. Reports have signalled a series of tough new rules recommended by the Bank of England, but the flipside might well be a new creativity in motivating the money makers.

Under these new regulations a banker could have all or part of their bonus clawed back if:

There is reasonable evidence of employee misbehaviour or material error; the firm of the relevant business unit suffers a material downturn in its financial performance; or the firm of the relevant business unit suffers a material failure of risk management.

In other words if you are found to have gained your bonus because of underhand activity, or the business you worked in goes sour, or it took on too much risk, then some or all of your bonus is likely to be taken off you. What is more, this comes on top of three to five years during which your bonus is deferred in many large banks.

These measures might seem harsh. And they are. They are inspired by more than just the findings of the Parliamentary Review of Banking Standards which concluded that the way bankers are paid needs to be fundamentally rethought. A range of inquires have concluded that the practice of providing large cash bonuses for short term performance was one of the most important drivers of the excessive risk taking in the lead up to the financial crisis.

Loading up on risk

This is because bankers were incentivised to take on risky positions which would look good in the short term (resulting in a large bonus) but would most likely turn sour in the longer term. It didn’t really matter that bonuses were likely making them miserable anyway. What this meant is that while bankers walked away with large bonuses, banks and ultimately the tax payer were left holding toxic assets. It followed that an important part of any campaign to clean up the banking sector would involve reforming the way bankers were paid.

The banks had already got in first, increasing the amount of shares which were part of bankers remuneration packages. This effectively would tie their own fourtunes to the bank – so they would only prosper if the bank prospered. The banks also increased the period over which remuneration would be paid out. The hope was this would develop a longer term orientation among bankers. Clearly the reported announcements due tomorrow mean that the Bank of England does not think these voluntary measures go far enough.

Clearly the measures of deferring bonuses for a lengthy period of time are likely to make the banks safer. Bankers are likely to avoid wrong-doing as they know their bonus depends on it. They are also likely to think about the long term, because they know if they make risky investments which will bomb in the longer term, they their bonus could disappear.

Lacking motivation

While these measures might benefit the banks, they are unlikely to make many bankers happy. There are a range of reasons for this. Psychologists have found that we tend to value rewards more highly if they come to us fairly quickly. This measures a small reward now is value more than a large reward in the future. What this means for bankers is that immediate rewards tend to be far more motivating than rewards which are deffered for years. It is unlikely that the uncertain promise of a bonus in seven years is likely to be particularly motivating to many bankers. In addition, many bankers will be justly worried that the long period of time before their bonus is paid off could see whole business units fundamentally change through no fault of their own, resulting in their bonuses being at risk.

The upshot of all of this is uncertain. It will probably mean an end to the over-the-top spending during bonus season which was a fixture of the London economy before the financial crisis. This is likely to have a knock-on effect in industries including elite schools, luxury watches and expensive cars (not to mention the entertainment industry). It could result in perverse effects whereby bankers continue to demand ever greater bonuses given the increasingly lengthy pay-off horizon. It could also mean that employees in large UK banks go in search of large and relatively immediate bonuses elsewhere.

This could result in an exodus from UK banks or a swelling of the far-less regulated shadow banking sector. A final outcome could be that the UK banks are forced to think about alternative ways of motivating their employees. If bonuses cease to be effective, then they are going to have to start offer work which has healthier hours, is more secure, offers more opportunities for learning and development, and is less aggressive and abrasive. Most other industries have learnt that, time for the banks to follow suit.

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