Remuneration in banking: two lessons from history and current policy

Abstract

The paper evaluates the current approach to remuneration policy in the financial sector through the lens of the history of pay proposals.This history can be seen as a series of attempts to align interests of financial firms' insiders with interests of a varying range of outsiders.Even though interests were getting aligned, excessive risk taking remained, because each proposal overlooked an important group of outsiders.The history offers two lessons relevant for the current debate.First, modern banking involves an important group of outsiders overlooked by the current pay policy -ultimate asset holders.Their interests could be taken into account by separating remuneration policy for commercial and investment banking and by linking pay in investment banking to performance of securities originated, floated and traded.Second, the persistent problem of overlooked outsiders suggests that the very approach to pay in commercial banking should be changed.Instead of searching for an indirect alignment, remuneration could be linked directly to leverage-adjusted profitability of commercial banking operations, making the remuneration policy a tool of countercyclical macro-prudential regulation.The proposed measures could supplement and strengthen the current remuneration policy focusing on the bonus cap and deferred compensation subject to malus and clawback.The paper makes particular reference to the current UK remuneration policy, the core arguments and conclusions, however, apply to a broad range of countries.