Bonuses Make Bank Failure More Likely

Anatole Kaletsky Times December 4, 2009

Attend a special evening hosted by Mike Atherton

Taj Hargey

Where am I?

If the Royal Bank of Scotlandâ??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 yearâ??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 todayâ??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 â?? 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 Governmentâ??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 taxpayersâ?? 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 â?? 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 taxpayersâ?? 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 Goodwinâ??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 shareholdersâ?? capital, not a reward for the efforts of the bankâ??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 â??eat what you killâ? mentality, as the director of one leading US bank describes it, was a root cause of last yearâ??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.

Order By:

Would you like to post a comment? Please register or log in

function blogURL(bUrls) { window.location=bUrls; } fieldset { float:left; width:165px; border:0px; margin:0px; padding:0px; } OUR COLUMNISTS

Columnists

Select David Aaronovitch Simon Barnes Camilla Cavendish Jeremy Clarkson Giles Coren Robert Crampton Daniel Finkelstein Michael Gove Anatole Kaletsky India Knight Dominic Lawson Leo Lewis Rod Liddle Magnus Linklater Ben MacIntyre Bronwen Maddox Minette Marrin Carol Midgley Caitlin Moran Richard Morrison Matthew Parris Michael Portillo Libby Purves William Rees-Mogg Melanie Reid Peter Riddell Hugo Rifkind Sathnam Sanghera Frank Skinner Graham Stewart Andrew Sullivan Rachel Sylvester Janice Turner Guest contributors

Blogs

Select Alpha Mummy Archive Blog David Aaronovitch Asia Exile Baby Barista Blockbuster Buzz Gerard Baker Charles Bremner Big Brother Mary Beard Comment Central Consumer Central Cricket Blog Eco Worrier Faith Central Fashion Formula One Ruth Gledhill Inside Iraq Ariel Leve India Knight Money Rafael Nadal News Blog William Rees-Mogg Rugby Sinofile Mick Smith Sports Commentary Irwin Stelzer Peter Stothard Surf Nation Technology Travel Urban dirt Video Wimbledon

Anatole Kaletsky

Anatole Kaletsky writes for The Times Comment pages on Thursdays. One of the country's leading commentators on economics, he was formerly Economics Editor and is now Editor-at-large of The Times. He has won many awards for his financial and political journalism. Before joining The Times, he worked for 12 years on the Financial Times

Read more from Anatole Kaletsky Cartoon More cartoons Peter Stothard

The Editor of the TLS writes on books, people and politics

A Don's Life

Mary Beard of Cambridge and the TLS on culture ancient and modern

NEWSFLASH: Barack Obama is... British? Comment Central MOST READ MOST COMMENTED MOST CURIOUS Most Read Skip Most Read Today Amanda Knox pleads against 'killer's mask'... Vladimir Putin praises Stalin for creating a... The 50 Biggest Movies of 2009 Tiger Woods: hostess Rachel Uchitel 'will... MOST COMMENTED Skip Editor's Pick Today if(isArticle == "true" && articleHeadlines.length!=0){ for(var j=0; j=45){ headline = articleHeadlines[j].substring(0,44)+"..."; } document.write(""+headline +""); } }else{ fSubmitMostCommented('http://community.timesonline.co.uk/ver1.0/Direct/Process'); } MOST CURIOUS Skip Most Curious Today Celebrity Watch: Easy Tiger Woods! Boom in bird tables has changed evolution of... Robots enlisted by British Library to help... £40m offer to buy Blackpool Tower and... Focus Zone Need to Know:

Industry sectors news at a glance. Interactive heatmap, video and podcast

Business Travel:

Everything the Business Traveller needs to know to make a better trip

Winter Sports:

Get ready for the winter sports season, with our resort guides and snow reports

Mapping Business:

We are backing British business, what is the confidence of the nation and what businesses are succeeding?

The Future of Energy:

Growing demand for energy, oil that is harder to reach and the rise of carbon dioxide emissions. We examine the energy challenge

Europe by Train:

With rail travel in Europe on the rise, we review the benefits of travelling by train

My Dinner Party:

In this special section we explore new food trends to help improve your dinner party and impress guests

More reports:

Enjoy further reading from Travel to Fashion, Business to Sport, discover more

Need to Know Business Travel Winter Sports Mapping Business The Future of Energy Europe by Train My Dinner Party More reports Births, deaths, marriages

Place your announcement

Encounters Dating

We'd love to find you someone special

Crossword Club

Free CV Review

Sell yourself! Have your CV reviewed by experts

Announcements

Search The Times Births, Marriages & Deaths

Online Sudoku with daily prizes Find a Lawyer

Cut your legal costs

Classifieds Cars Jobs Property Travel Cars Skip Cars of the Week Ferrari F355 F1

1998 £47,955

Virgin Car Insurance

12 months for the price of 11 and a 5% discount. Offer ends 31/11/09

Apply for car finance?

Check your free Experian credit report before applying

Great car insurance deals online

Car Insurance

Search for more cars and bikes Jobs Skip Jobs of the Week LAY MEMBER

£353 per day Phonepay Plus London

Consulting Roles All Levels

PwCâ??s Consulting practice helps businesses of all shapes and sizes work smarter and grow faster PwC

Chair of the British Library

£37,000 Department for Culture, Media and Sport London

Member of the BBC Trust

Currently £36,285 Department for Culture, Media and Sport London

Search more Jobs Properties Luxury development in the heart of Battersea.

Moments from Battersea Park.

Double-fronted 4 bed, 4 reception house near Eltham Palace.

For sale with Winkworth

Eager to get on the property ladder?

Find out about shared ownership.

Looking for a Mortgage?

See your free Experian credit report beforehand

Search for more properties Holidays Skip Travel of the Week Malaysia Grand Prix with Premier Holidays

Accommodation, flights, tickets to the race and a KL city tour for only £999pp PremierHolidays.co.uk

Ski Weekend Specialists since 1986

For your?ultimate tailor-made ski holiday, click here

Great Travel Insurance

Get covered on your travels with a superb range of policies at great prices. Visit InsureandGo.com

Fabulous Villas in Barbados

World Class Golf, Spa and preferential Beach Club.??Private estate overlooking West Coast Villas from £275 per night inclusive of Golf

Search for more holidays Place your advert now

Search Ad Reference:

Where am I?

Home Comment Columnists Anatole Kaletsky Contact us Back to top NewsCommentBusinessMoneySportLife & StyleTravelDrivingArts & EntsArchive Times Online Times Archive Google TLS Archive

Contact our advertising team for advertising and sponsorship in Times Online, The Times and The Sunday Times, or place your advertisement.

News International associated websites: Globrix Property Search | Milkround

This service is provided on Times Newspapers' standard Terms and Conditions. Please read our Privacy Policy.To inquire about a licence to reproduce material from Times Online, The Times or The Sunday Times, click here.This website is published by a member of the News International Group. News International Limited, 1 Virginia St, London E98 1XY, is the holding company for the News International group and is registered in England No 81701. VAT number GB 243 8054 69.