Controlling and Monitoring a Bankers Bonus Finance Essay

1. Introduction

Huge bonuses for bankers is believed to be the instrument of reckless risk taking, which at the very least contributed the credit crisis and great recession, if it is not a principal and direct cause. It is widely controversial that whether controlling bankers' bonus should be a part of a package of macro prudential regulation. This essay advocates that controlling bankers' bonus should be a part of a package of macro prudential regulation for that paying big bonus to bankers is a collective behavior of banking institution which expands risk and jeopardizes the stability of the banking system. The essay ponders over the reasons that empirical fact proves the positive link between risk taking and pay-off to the bankers, that the bonus system existing in banking industry nowadays is asymmetric as well as an incentive to short term return at the expense of long term profit, retorting two arguments that high bonus in banking industry is determined by market value law as well as that cutting bankers' bonus would cause outflow of talent in banking industry, and mention that two concerns regarding controlling bankers' bonus should be addressed.

2. Background

The global economy is looming, struggling to recovery from the aftermath of the financial crisis two years ago. Overindulging risky activities contributing to the severe financial crisis that was experienced for the first time since the Second World WarA¼Å’bankers' bonus is in the spotlight.

The bonus in banking industry is eye-popping high. According to New York State Comptroller Office, London and the City Prospects, Wall Street Journal estimates and Centre for Economic and Business Research estimates, from 2002 to 2007, the bankers' bonus in the US surged from 9.8 billion dollars to 33.2 billion dollars. The year of 2008 witnessed a slump of the bankers' bonus to 18.4 billion dollars due to the financial tsunami. However, it is estimated that the bankers' bonus bounces back to 27.5 billion US dollars in 2009 in spite that the bank industry still suffers from the tremendous loss. It is a similar case of UK. After decreased drastically from the peak of 2007 at 10.2 billion pounds to 4.0 billion pounds in 2008, the bankers' bonus in UK boomed to 6.0 billion pounds in 2009 as if the financial crisis has never happened. Examining the individual bank, the Royal bank of Scotland is at the front line. It posted catastrophic losses, the amount of which is as high as 3.6 billion pounds; it was paying 1.7 billion pounds in bonuses. The fact that the bank was bailed out by tax payers all around the country last year makes the figure of bonuses paid to bankers more outrageous.

Several countries have already taken initially to introduce measures to impose curb on bankers' bonus. Netherland puts a cap on banker's bonuses, limiting the bonus should never exceed the base payment. UK levies a 50% tax on bankers' bonus.

Macro prudential regulation is defined (Borio 2009) as: " policy focused on financial system as a whole; treats aggregate risk as endogenous with regard to collective behavior of institutions; aims to limit system wide distress so as to avoid output". It is designed to supervise the collective behavior of financial firms to maintain the stability of the financial system at general.

3. Controlling Bankers' Bonus

There crops up a heated debate over the hot potato of that should bankers' bonus be controlled as part of a package of macro prudential regulation. Frankly speaking, I advocate that bankers' bonus should be controlled as part of a package of macro prudential regulation.

Despite of the versatility of the reasons in favor of that controlling bankers' bonus should be a part of the macro prudential regulation, I would pore over three of the most significant ones.

What's of top priority is that the empirical fact proves the positive relationship between bankers' compensation and the risk taking. According to the research run by John and Qian(2003) and Brewer et al(2003), there is a positive connection between risk and pay-offs to bankers. Their studies from 1992 to 2000 in the US confirm that the pay-offs to the bankers positively links to the risk that bankers take. The research provides a sound premise for the regulation of controlling bankers' bonus.

On second thoughts, controlling bankers' bonus becoming part of macro prudential regulation will modify the asymmetric bonus system thereby diminishing risk of the banking system. The bankers' bonus structure existing now is very unreasonable. The employees of the banks are regarded risk averse, who don't want to be involved in risky business so that their jobs can be secured. Therefore, they have to be paid extra to take risk. However, the bonus system is asymmetric, under which bankers will gain a considerable amount of bonus if banks make profits from spectacular activities; on the contrary, in the case that banks suffer from the spectacular loss, bankers are immune to losing the bonuses they got before, let alone making a forfeit. Under such an absurd one-way system, in order to make a bonanza, bankers will never hesitate to take as much risk as they can. Filled with greed, bankers try their best to exploit every opportunity to gamble with financial derivatives to expand their bonus they get at the end of every year even when they are aware that their behavior may be very risky to the banks. Therefore, neither the risk can be well managed nor next credit crunch can be prevented until the asymmetric bonus system is revised by incorporating into macro prudential regulation.

Saving last for the best, absorbing controlling bankers' bonus into macro prudential would adjust bankers from focusing on short term return to attaching importance to long term benefit, so that the risk of banking system would shrink. The bonus system existing nowadays encourages the CEOs and other key employees of the banks to only lay emphasis on short term return. It is inevitable and irrefutable that banks pay bonus for good performance whilst the crux lies in that how we define good performance. If the so called good performance stands for making spectacular short term profit, the bonus scheme possibly leads to a catastrophic result to the bank. Compensation based on accounting profit tend to reward staff of banks for short term results when in the long term, their investment decisions may have severe consequences on their capital base. It may lead CEOs and senior executives to make decisions that proliferate short term profits while long term growth is compromised. This is what was experienced before the time of the financial turmoil - brilliant bets which earned high profits for huge companies, but with time, they were tumbling down exposing banks to losses of tens of billions. The immediate gains which are the determinant to the bankers' bonus can also be augmented easily by managerial skill. The bonus system attracts exact people lack of long vision. It is not prudent to pay huge bonuses unless they can be linked to certain investment decisions which have long-term results. A bank should either base bonuses on long-term results or come up with a claw back mechanism that will benefit the entire institution. Hence, controlling bankers' bonus should become part of macro prudential so that the bankers would no longer concentrate on short term return, instead, they would also pay ample attention to long term benefit.

There is a myth concerning the consequences brought by adding controlling bankers' bonus to macro prudential regulation that can be exemplified by that it would result in talent outflow of the bank, wrecking the stability of the financial system.

Some people try to justify the bankers' bonus as a necessary way to attract and retain financial elites, relying on a defective argument that staff will jump ship if they don't receive millions in bonuses. They argue that controlling bankers' bonus is a vote-catching exercise which would be detrimental to the banking system and an unfair attack from people in other industries who are jealous of huge bonus gained by the bankers for that the curb of bankers' bonus would exert seriously adverse influence on the human resource pool, not only putting banking industry in a negative position with a unfavorable disadvantage in the cut throat competition of human resource, but also eroding the banks' capability of gaining profit and managing risk. In fact, the demand from other industry to banking talent is very limited, hence controlling bankers' bonus would not cause brain drain of large scale in banking industry. Especially in such a circumstance today, staff in banking industry should be very grateful for being employed given that the rate of unemployment stays at a very high level for a long period. Besides, it implies that the banks are not doing enough jobs in creating employee loyalty if they are ready to resign when the amount of bonus is not that huge. In addition, as the bonus scheme existing now is only attractive to those who focus on short-term benefit and have overwhelming desire for money, controlling the bankers' bonus would be helpful in filtering short sighted and greed bankers, so that the banks can be run by responsible bankers with long vision, which is definitely conducive to the banking system. It is delightful to see that Eric Daniel who in charge of Lloyds and two top men at Barclays have all decided to give up their bonuses. Their behavior can be interpreted as a positive signal of the change of the bonus culture in the banking sector and the support to adding controlling bankers' bonus to macro prudential regulation. On the ground of reasons mentioned before, controlling bankers' bonus becoming part of macro prudential regulation would never cause brain drain in banking industry.

However, each jade has its freckle. There are two concerns in regard of what may occur after controlling bankers' bonus being absorbed into macro prudential regulation.

Firstly, some people are afraid that the macro prudential regulation of controlling bankers' bonus would be a Pandora's Box, concerning that it may spark exodus of financial elites. As we know, bankers are capital characterized by high mobility. The stringent control of the bankers' bonus would be the instrument for a country of losing the fierce competition of human resource. The slimmer bonus may drive the CEOs and senior executives of the bank industry flee to the countries with less rigid regulation on bonus and start banking business there. Moreover, the advanced technology facilitates the immigrant. In such a high-tech and globalization era, financial service can be provided through the internet and financial transaction can be undertaken all around the world. As a result, the cities such as London and New York would no longer hold the position of financial centers. As banks play a crucial role in an economy, the exodus of the bank industry would be detrimental for the entire economy at general. The comprehensive competitive force of the city and whole country would be seriously deteriorated. To address this problem, the major countries in the world should joint their hands to incorporate controlling bankers' bonus to the package of macro prudential regulation. Only when the macro prudential regulation of controlling bankers' bonus prevails in the major countries of the world, the concern can be relieved.

Secondly, when the macro prudential regulation of controlling bankers' bonus put into force, plenty of undesirable and unintended behavior to escape from the control would surely generate. For example, bonuses could be swap to the base pay. There are numerous consultants can help bankers to find ways to avoid the control, or the bankers themselves are experts in staying away from the curb. Therefore, when controlling bankers' bonus becomes a part of package of macro prudential regulation, we should pay attention to the potential way that the bankers may come up to deal with the regulation. A series of detailed and specific rules should be formulated so that the regulation of controlling banker's bonus can be carried out well.

4. Conclusion

The empirical facts establish a positive relationship between payment to the bankers and their risk taking behavior, the bonus system existing now is asymmetric and encourages bankers to only focus on the short term return. Controlling bankers' bonus will not make the bank suffer from brain drain. The major countries in the world should work together for the regulation of controlling bankers' bonus and the regulation should be well designed so that bankers won't be able to find ways to get avoid of it.

To sum up, paying big bonuses to bankers is a collective behavior of banking institution which expands the risk and jeopardizes the stability of the banking system, so controlling bankers' bonus should be taken into a package of macro prudential regulation.

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