This October has seen the removal of the cap on bankers’ bonuses, as part of a suite of rule changes by the UK’s financial regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). The removal has drawn a lot of column inches, much of which has been negative around its impact on banking culture and the timing of this during the cost-of-living crisis. But who will be affected by this? Will the rule change have any real impact on banking culture? Let’s get underneath the headlines and review what is happening and to do so, let’s go back to the circumstances from which the original cap stemmed.
In 2014, the European Union introduced the bonus cap, which limited bonuses to twice basic pay. The objective of this was to make the financial system safer by reducing the kind of excessive risk taking that led to the Global Financial Crisis of 2008. Initially, the UK Government opposed its introduction but was forced to back down after the European Court of Justice rejected the UK’s challenge to EU legislation.
Last autumn, the then Chancellor of the Exchequer, Kwasi Kwarteng announced the scrapping of the bonus cap in a bid to make the UK a more attractive financial hub post-Brexit. Then in December 2022, as part of host of a package of reforms (known as the Edinburgh Reforms) introduced by the then new Chancellor of the Exchequer, Jeremy Hunt, the PRA and the FCA launched a joint consultation paper, PRA CP15/22, a 4-month-long public consultation, that in the event, only received 12 responses. Around this time, an interesting Bank Underground Blog was published. In this, authors from the Bank of England’s Prudential Policy Division acknowledge the broad consensus that some senior bankers’ renumeration packages contributed to the Global Financial Crisis because they created reward structures which incentivised excessive risk-taking. Following the crisis, many regulators introduced requirements including bonus caps, deferrals, malus and clawbacks to remedy this, and in the UK and Europe, this included reporting requirements. As a result, there is detailed data on staff remuneration, which is analysed in the Bank Underground blog. Taking the data of six large UK banks the authors looked at how two rules – the bonus cap and payment deferral – affected bankers’ pay. Their research finds no evidence that the bonus cap significantly constrained growth in the total remuneration for material risk takers (MRTs), but rather led to a slower bonus growth and a sharper increase in fixed pay. This supports some theoretical hypotheses: that deferring individuals’ pay might be creating a need to compensate them for postponed consumption. The authors note that their analysis does not establish whether such costs outweigh the benefits of the bonus cap and deferral rules, which is beyond the scope of their work.
Which brings us back to the recent HM Treasury/PRA/FCA joint policy statement. In its simplest terms, what is changing are the current maximum limits set on the ratio between fixed and variable pay. These are to be lifted from the regulators’ respective rulebooks. Alongside this, both the PRA and FCA have drawn up additional guidance on the factors firms need to consider when setting an appropriate ratio between fixed and variable pay.
The important point raised in the Bank Underground research and in the policy statement itself, is that changing the rules on bonus caps and deferrals may help to control the growth in fixed pay: this cannot be clawed back from bad actors or when qualifying criteria are not met. Despite the changes to these rules, and for some it will be possible to earn more variable pay, the appropriate controls of deferral (a proportion of pay is postponed to a later date), malus (part of a deferred bonus not paid out and that cannot be reclaimed if criteria are not met) and clawback (when a bonus has been paid out but must be returned) remain.
As Steve Pateman, President of the Chartered Banker Institute observes, “The changes made to the ways that banks manage capital, liquidity and risk since the Global Financial Crisis provide strong guard rails and whilst there have been bank failures, the resolution has been effective and losses have sat with shareholders and bond holders not the general public: remuneration can encourage excessive risk taking and increase the risk of loss or failure however those losses now sit with the providers of capital and they and the regulator will expect Boards to ensure that their remuneration policies do not place that capital at undue risk.”
Who will be affected by this?
It’s important to note that this will only impact a small number of individuals (e.g. senior management and executives, material risk takers, and those whose pay takes them into an equivalent remuneration bracket), and is more likely to be relevant to investment bankers and traders. As the professional body for retail and commercial bankers, we are well aware that most of our members – and most individuals working in banking and financial services in general – receive salaries that are comparable with other professional services. It is right that the banking sector is sensitive to cost of living challenges that exist but the level of reward at an individual level is ultimately for the board of each bank and its shareholders to decide.
How might this impact banking culture?
There are many other aspects that drive culture (including governance, education, employer and professional norms, for example) but remuneration and incentives are certainly key and it is important that changes to these don’t send wrong signal to bankers, customers and to society overall. With the data available to regulators, and the current levels of interest in this rule change, there will no doubt be further analysis in due course, monitoring its real impact on pay and reward, and on culture. The FCA has written to Chairs of remuneration committees, explaining the changes and reminding them of other considerations to factor into their decisions, such as the alignment of firm and individual conduct with the Consumer Duty, as well as improving diversity and inclusion, and progress towards sustainable goals and the transition to net zero.
Removing the bonus cap has shifted focus again to the importance of culture in financial institutions and across our profession, which is perhaps a positive to come from this change at this time. At the Institute, we believe the foundation of a successful and sustainable banking sector is professionalism – ensuring that banking is conducted in a socially-purposeful, ethical manner that places customers and communities at its heart. Our 37,000 members make an individual commitment to doing so through the Chartered Banker Code that binds us, and provides the basis for a common, global culture of professionalism. Investing in banking professionalism is where financial institutions, regulators and others should focus, in our view, if they really want to enhance and sustain a banking and financial sector of which we can be proud and on which the public can rely. For those members who want to learn more about banking culture, catch up on our recent webcast “How are policymakers and regulators changing banking for good?” or listen to our series of podcasts on credit and lending in a cost of living crisis.
