Big bank bonuses make failure more likely
If the Royal Bank of Scotland’s board have genuinely threatened to resign over the right to pay £1.5 billion of bonuses, they should be asked to do so immediately.
Their mass resignation would offer the Government a golden opportunity to correct all the managerial mistakes it made when it took over RBS and the other banks in the heat of last year’s crisis.
The first mistake was to pack their boards with traditional City types who were intellectual clones of the people who had caused these institutions to collapse. In the case of RBS, all seven of the new directors appointed by the Government in late 2008 and early 2009 were either former bankers or insurance executives. The remaining five members of today’s board are all hangovers from the previous regime, amazingly left in place by the Government despite their presence as directors at the time when Sir Fred Goodwin destroyed the bank.
If these people threaten to resign, the Government should jump at the opportunity to clear them off the board, with no need for compensation payments of any kind.
Who could run RBS if all these luminaries removed themselves? The answer is people with a sense of public service who have done well enough in other careers not to worry too much about the modest remuneration on offer — the sort of people who run public bodies such as the Royal Opera House or lead public inquiries into the reform of the health service. Such directors could be drawn from small-business lobbies, hedge funds that had made money by speculating against bank stocks and maybe even a few trade unionists and consumer lobbyists.
A new RBS board could then start to correct the more serious managerial mistakes perpetuated by the Government after it took the banks over.
The first was the idea that RBS or other state-owned banks have to pay competitive salaries to succeed in global financial markets and thereby eventually repay the Government’s investment. In fact, the opposite is true. The higher the salaries paid by RBS or any other bank, the more likely it is to fail, taking taxpayers’ money with it. The obvious and much discussed reason is that high salaries in finance generally reflect high-risk trading strategies. If strategies fail, the losses fall on shareholders of the bank or taxpayers who must ultimately guarantee all banks, as the world discovered after Lehman — not on their highly-paid and supposedly talented employees.
To maximise the chances of recouping its investment in RBS, therefore, the Government should ensure that the bank is run in the dullest, most risk-averse manner. This is especially true in the present economic environment, when banks can borrow money for nothing from the Bank of England and then lend it out extremely profitably to homeowners, businesses and even, through the gilt-edged market, to the Government itself. Under these conditions, the simplest banking operations should be quite profitable enough to recoup taxpayers’ money. Replacing every £1 million bond trader with ten local branch managers earning £100,000 would certainly make RBS safer and probably, in the present economic environment, more profitable as well.
If limiting the size of the bonus pool encouraged the traders and investment bankers at RBS to move elsewhere, their departure should be a cause for celebration, not concern.
What would then happen to the huge trading and investment banking businesses at RBS run by these highly paid and talented employees? RBS, even more than Lloyds or Northern Rock, is a vast conglomerate handling every aspect of finance from car insurance to derivatives trading. The idea that the combined value of all these activities was greater than the sum of the parts was just another of Sir Fred Goodwin’s costly illusions.
Now that global stock markets are on the road to recovery, selling off the higher-risk and more complex parts of RBS piecemeal would probably be more profitable than trying to keep the group together.
For example, if the private bankers at Coutts need to earn more than the branch manager in Bootle, and they almost certainly do, then the sensible course of action would be to sell Coutts to another bank or float it on the stock market as an independent business, rather than to allow the strategy of RBS as a whole to revolve around the needs of this highly profitable but specialised business.
The same could apply to the specialised capital markets, trading and corporate finance operations. These are the parts of RBS that pay really high salaries.
Which leads to the question of why bankers earn so much more than other similarly qualified workers. Is it really because they are so uniquely talented? Or is it because they have access to pools of capital, backed up by explicit or implied government guarantees? The answer is obvious and it means that most of the money that banks earn should be seen as a return on shareholders’ capital, not a reward for the efforts of the bank’s employees.
Any other revenues they generate belong to the shareholders, not to the employees. This is as true for oil company geologists and nuclear engineers as for street-sweepers or navvies. Yet bankers believe that they belong essentially to them and should go into a bonus pool, rather than being paid to shareholders as dividends or retained as extra capital to build up the financial strength of the bank. This “eat what you kill” mentality, as the director of one leading US bank describes it, was a root cause of last year’s crisis.
The solution is clear. Rather than try to limit pay and bonuses directly, governments and regulators should simply insist that banks use all the revenues that they generate to increase their capital strength. In the case of RBS, a simple demand that the bank add a further £1.5 billion to its capital would drain the bonus pool and solve the problem.