Financial Services Authority attempts to involve itself in the regulation of banks remuneration policies in light of the global financial crisis
The panic in world financial markets has led to sharp falls in share prices and led to the contraction of credit markets. In examining the causes, some commentators have focused on the asymmetry between the excessive risks taken by bankers on behalf of their employers and the personal rewards received.
Mervyn King, Bank of England Governor, recently told a Treasury Select Committee: "I think that banks themselves have come to realise, in the recent crisis, that they are paying the price themselves for having designed compensation packages which provide incentives that are not in the long run in the interests of the bank themselves, and I would like to think that that would change."
Speaking at the 25th Anniversary Summit of the British Venture Capital Association, Richard Lambert, the Director General of the CBI, said "It's clear that a number of investment banks had overlooked basic risk controls in their drive to increase profits. This pattern of behaviour has been exacerbated by a remuneration structure which has encouraged some employees to take spectacular short-term risks, confident that if things work out well they will reap huge rewards, and if they don't, they won't be around to pay the price. If it had been their own equity at risk, things might have played out differently."
FSA focus
The Chief Executive of the Financial Services Authority, Hector Sants recently told a dinner held by the Investment Managers' Association that the regulator would consider the implications of remuneration structures when judging the overall risk of individual institutions "with increasing intensity". Mr Sants later told the Financial Times "When we look at risk, we should be looking more than we have in the past at compensation structures that encourage risk-taking."
Within the mechanisms of the Basel II Capital Accord, if the FSA believes that the remuneration packages of bank employees incentivise them to behave in particularly risky ways, it would have the power to force the bank to increase the amount of capital it must hold in order to safeguard its solvency and overall economic stability.
Will this focus by the FSA have the effect of curbing "the excessive build-up of risk-taking and credit creation" described by Mr King? Additional capital requirements would certainly make it more expensive for any bank to promise its key employees huge rewards for making risky bets with the company's balance sheet. However, as the financial industry competes on a global stage, the risk that talent may defect to firms outside the FSA's jurisdiction may prove too large to effect great change in this area.
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