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- Title
Bonus regulation: aligning reward with risk in the banking sector.
- Authors
Angeli, Marilena; Gitay, Shahzad
- Abstract
In the years leading up to the financial crisis, bonus payments more than doubled in the finance and insurance industry - significantly outpacing growth in overall spending in the economy (shown by nominal GDP in the summary chart). There is broad consensus that banks' remuneration policies were a contributing factor to the financial crisis. This included rewarding high short-term profits with generous variable remuneration awards (like bonuses) by encouraging excessive risk-taking that did not consider the long-term risks created for banks and, ultimately, wider society. The global regulatory response sought to align incentives with risks taken. In the United Kingdom, the Bank of England's Prudential Regulation Authority has implemented rules to achieve this with a view to improving the safety and soundness of individual firms and the resilience of the financial system. Requiring the size of awards to employees to be determined by a balanced suite of metrics, and requiring awards to be paid at least 50% in non-cash instruments which tie the size of the award to the longer-term performance of the firm, should help to align incentives from the outset. Deferring awards means they can be adjusted to reflect longer-term risk horizons. From 2016, deferral periods of up to seven years from the date of payment will apply. Through reduction of unvested awards ('malus') and reclaiming vested awards ('clawback'), ex-post adjustments can be made up to ten years from the initial date of award. Finally, variable remuneration payments must not limit firms' abilities to strengthen their capital bases. Looking ahead, remuneration remains on the agenda for regulators around the world. As Governor Carney said in November 2014, 'Senior manager accountability and new compensation structures will help rebuild trust in financial institutions'. One consequence of the regulation of remuneration, particularly the introduction in the European Union of the bonus cap, has been an increase in fixed remuneration as a proportion of total remuneration. As with excessive variable remuneration without appropriate incentives, this can also impact negatively on resilience within the financial system. Higher fixed pay limits the proportion of total remuneration that can be used to absorb losses in a downturn and that which is aligned to long-term risks. The global regulatory focus is on the need to ensure a sufficient portion of remuneration remains 'at risk' of being reduced or eliminated and on the role of incentives in reducing misconduct.
- Subjects
UNITED Kingdom; EMPLOYEE bonuses -- Law &; legislation; BANK of England. Prudential Regulation Authority; MISCONDUCT in public office; BRITISH banking industry; WAGES; PREVENTION
- Publication
Bank of England Quarterly Bulletin, 2015, Vol 55, Issue 4, p322
- ISSN
0005-5166
- Publication type
Article