This week it has been used to great effect – in the final hours of the Spanish presidency of the EU, Labour’s Arlene McCarthy secured council of ministers and European commission backing for the new Capital Requirements Directive (CRD 3), which will place strict limits on bonuses, particularly bailed-out banks. CRD 3 will dramatically change the culture of excessive pay for directors of banks and investment firms
The directive is a response to the major weaknesses in banking practices revealed by the financial crisis. A combination of rewarding high-risk, short-term activities with massive bonuses, and severely undercapitalised banks meant that, when the sub-prime crisis hit, banks had to be bailed out with massive sums of public money. The position of the McCarthy report and the Socialist group of MEPs was that bank and investment firm remuneration policies should not encourage excessive risk taking and should be closely tied to the capital strength of their institution.
The main achievements of McCarthy and the Socialist group include strict limits on upfront cash bonuses to ensure that bonuses are linked to long-term success rather than mere risk-taking. The maximum amount of upfront cash is 30 per cent of a bonus, and 20 per cent for large bonuses of £1 million or over. The rest must be in either contingent capital or shares, must be deferred, and can clawed back if investments do not perform. Indeed, at least 50 per cent of the total bonus must be in contingent capital and shares, meaning that bonus payments are closely tied to the strength and performance of a bank.
For bailed-out banks, the rules are, rightly, much stricter. Nationalised banks will be required to prioritise repaying taxpayers and strengthening their capital bases over paying bonuses. Another success is that the example of Fred ‘the shred’ Goodwin walking away from a bankrupt RBS with a multimillion pound pension pot can’t happen again, as the value of large pension payments will also have to be linked to the strength of the firm. Had this been the case three years ago, Goodwin’s ill-deserved pot of gold would have been decimated.
It has been argued that banks will get around restrictions on bonuses by simply increasing salaries. But there is international agreement that there should be a proportionate balance between salaries and bonuses in the financial sector. On this point, CRD 3 compels every bank to establish limits on bonuses in relation to salaries.
Of course, this legislation isn’t the ‘silver bullet’ that will immediately change the financial world. Successful financiers will still be paid large sums of money and, compared to 99 per cent of people, be extremely well paid. But it will, almost certainly, change the cultural mentality of investment firms and banks – with long-term success rewarded rather than reckless short-term risks.
Indeed, an astonishing fact is that while the financial sector caused the recession which ordinary people paid for and, through George Osborne’s savage budget, will continue to pay for, banks have actually increased bonus payments since the crisis. Not by a small amount, but by £10 billion, according to the bank of England’s financial stability report published last week. That £10billion could have been used as capital to support small businesses and prevent families from losing their homes.
Moreover, this directive also marks out political dividing lines between Labour and the ConDems on changing the culture of the City. Osborne’s ’emergency budget’ may have proposed a bank levy that will raise £1.2 billion, but considering the £850 billion of taxpayers’ money that has gone into propping up the banks, this is a tiny drop in the ocean. Indeed, it is half the amount raised by Alistair Darling’s levy on bonuses last year. Now it is Labour MEPs who are leading pan-European reform of the financial sector.
The new directive will become EU law within the next month or two, but then it is up to member states how quickly and strictly they implement the law at national level. It will hurt the Tories (and some of their wealthy Lib Dem colleagues) to have to implement legislation that will hit their City chums in the pocket, especially given that Osborne apparently didn’t know about the proposed deal on CRD 3 until the decision had already been made.
So Labour MPs should be proactive and start campaigning for a rigorous enforcement of this law, which will save the taxpayer a large amount of money and increase the capital base of banks, leaving them with no excuses for not increasing lending. We should ignore the bleating of bankers and investment firms that they will have to leave Britain and we will lose thousands of talented financiers. Similar threats were made following Darling’s bonus levy – the threatened exodus to Switzerland didn’t happen – and over £2 billion was raised in tax.
Besides, given the crisis that they caused, would anybody really miss these self-proclaimed ‘masters of the universe’?