Saturday, 9 August 2008

Bank bonus culture part of the problem

Say FSA chief Hector Sants in his interview with Robert Peston. High pay isn't just a question of fairness, we also need to think about (perverse) incentive effects. When you combine huge incentives with overconfidence it's not surprising that big risks get taken.
In relation to the causes of the credit crunch, Mr Sants disclosed that the FSA is unhappy at the way banks rewarded their star bankers during the boom years.

He says that there was an incentive on these bankers to take excessive risks with their firms' capital. That foolish risk taking has come home to roost in the form of massive losses on investments linked to US subprime lending.

Mr Sants said that the FSA would find a way to penalise any banks which continue to incentivise staff to take dangerous risks. He said there would be "consequences" for banks that pay employees too much for doing imprudent deals.

2 comments:

Nick Drew said...

this has to be right, and less dysfunctional bonus schemes are not hard to devise

I once worked in a very-high-bonus set-up (not a bank) where bonuses were only paid in paper (and paper which didn't vest for several years), so at very least employees were incentivised to do the right thing by the long-term share-price - which more-or-less aligned their interests with those of the shareholders

and encouraged the best performers to stick around, too

this isn't flawless but it's easy and addresses several of the more grotesque problems

Tom P said...

I think this is an area where companies really ought to have a rethink. the surprising thing is the total lack of interest (so far anyway) from big investors. given that UBS for example has acknowledged that remuneration was a contributory factor in its problems you would have thought there would be a desire for change.