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Banker bonuses’ regulatory puzzle

In Europe

By European Parliament Library | Bankers’ bonuses have been under debate with the review of the Capital Requirements Directive (CRD IV), meant to regulate the remuneration, but the European Parliament has sought to introduce a fixed cap.

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The fourth version of the Directive (CRD IV) now under consideration would transpose the Basel III framework into EU legislation. The Basel III package will strengthen capital and liquidity requirements in banks, but only includes restrictions on dividend and bonus payments relative to a bank’s capital.

As a second step towards regulating bankers’ bonuses, the EP’s Economic and Monetary Affairs Committee has pushed to strengthen restrictions on remuneration policy in the draft CRD IV text (rapporteur Othmar Karas, EPP, Austria). Parliament has consistently argued to introduce a cap on bonuses through a 1:1 ratio between fixed and variable pay, meaning a bonus could not exceed fixed pay.

Whilst bankers’ bonuses have been stoutly defended by politicians close to the City of London, Internal Market Commissioner Michel Barnier said he was “not shocked” by the EP’s amendments, and had earlier supported a fixed ratio. Barnier has considered there would be reason to act if “banks are incapable of self-discipline with regards to bonuses.” He has none the less underlined the importance of shareholders’ control over remuneration policies in this context. The Commission is planning to propose an initiative in 2013 that would increase transparency on remuneration policies, as well as granting shareholders the right to vote on a firm’s remuneration policy.

The EP and Council have repeatedly discussed the issue of bonuses within trilogue negotiations on CRD IV since the Committee adopted its report in May 2012. The bonus issue was one of the last to be settled, at a trilogue meeting on 27 February. As a result, the 1:1 ratio will apply automatically from 1 January 2014. A company’s annual general meeting may vote to allow a ratio of up to 1:2 but this would imply significant deferral of payment. The agreement must now be approved by the plenary and the Council.

Sceptics continue to make a range of arguments against the proposed cap:

  • Restricting variable pay would lead to higher fixed costs as banks raise basic salaries. This increase could reduce banks’ flexibility to cut costs in difficult times.
  • Due to their incentivising nature, limiting bonuses risks disconnecting pay and performance, which could affect the overall performance of banks.
  • Without global coordination, EU action could lead to relocation of banks outside the EU, or even towards a transfer of their activities outside the regulated banking system (known as “shadow banking”), as a means to gain a more favourable environment for attracting high-pay employees.

Sceptics also doubt that the proposed legislation affects the right level of employees within banks. The industry has criticised politicians for exploiting a “populist issue.”

Alternatives to regulating bankers’ bonuses through a cap include taxation of bonuses, the establishment of a ratio between bonuses and size of the bank’s balance sheet, the increase of obligatory capital ratios to decrease risks or the limitation of bank size to enhance control measures.

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