(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own)
By George Hay
LONDON, Sept 10 (Reuters Breakingviews) - Banks need to stop
putting the cart before the horse on pay. Most universal lenders
are still paying huge bonuses, even though it is commonly
accepted that their investment banking businesses are not
earning acceptable returns for shareholders. The obvious reform
is for banks to work out whether they are exceeding their cost
of equity, and pay out bonuses only if the answer is yes. But
for that to happen, there would also need to be a revolution in
In dividing the profit pie, contractual salary payments
ought to rank before returns to shareholders. But remunerating
shareholders can also be seen as a quasi-fixed cost that should
be met before additional staff bonuses.
As things stand, very few investment banks are earning their
cost of equity after bonuses are paid out, or make it possible
to discern whether that’s the case. Some, like Credit Suisse
CSGN.VX, don’t disclose divisional return on equity at all. Of
those that do, Barclays Capital managed 10.4 percent in 2011,
Royal Bank of Scotland’s (RBS.L) markets division mustered 7.7
percent, and UBS’s 7.2 percent. The cost of equity for these
investment banks, if they were independent entities, would be
appreciably above the levels for their overall groups.
The picture is further complicated by one-off charges,
sometimes taken “below the line” once bonuses have been accrued.
In 2011, RBS had over 1 billion pounds of “restructuring”
charges caused by the reshaping of its business, as well as
further hits from strategic disposals. But if one-offs happen
with regularity, as seems to be the case in investment banking,
they become ongoing expenses.
Second, universal banks can effectively choose what
proportion of their equity base backs their investment banking
arms. Both RBS and Barclays (BARC.L) work out their investment
bank ROEs by somewhat randomly assuming they have 10 percent
core Tier 1 ratios. If they were separate entities, they would
almost certainly need to hold more capital, so returns would be
Bank bosses, such as incoming Barclays chairman David
Walker, may support setting a cost of equity hurdle for bonuses.
The problem is that the lender that goes first risks sparking an
exodus to firms still willing to tolerate shareholder subsidy of
undeserved banker pay. Then again, the low rating of bank stocks
shows that lenders risk an investor exodus if they don't reform.
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(Editing by Chris Hughes and Sarah Bailey)
Keywords: BREAKINGVIEWS BANKS/PAY/
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