Wednesday, 20 May 2009

The revolution within – risks and rewards in banking

 

   Although MPs’ expenses have been the top news item in the UK for a few weeks now, bankers’ bonuses have retained a low hum in the background.

MPs in the Treasury Select Committee have recently turned their attention away from themselves to this other group of miscreants, placing blame for reckless and excessive risk taking on City bonuses.

This may seem an obvious conclusion, so much so that Management Today’s reaction is a simple ‘like, duh’!  However, it wasn’t that obvious at the time that all this risk taking was going on.  It wasn’t even that obvious last Autumn – I remember feeling that I had a minority view when I started linking bonuses to the gloomy environment.

Anyway, in this week’s special report on international banking, the Economist reports on the actions that the banks are starting to take to improve things:

“Banks will tie compensation more closely to performance and spread rewards over longer periods. It should be said that neither idea is foreign to the industry. Bonus pools based on profits (though not revenues, an indefensible practice) may be seen as a problem now but are clearly more closely tied to performance than a fixed base salary. Awards of shares were common within the industry before the crisis and caused employees, those of Lehman Brothers included, to suffer vast losses when share prices dropped. What the industry as a whole did not do well enough was to design pay so that it better reflected long-term risk.

The bonus/malus structure introduced by UBS in 2008, whereby a cash portion of a bonus award is held back at the end of a financial year and reduced if targets are not met in subsequent years, will also become more common as institutions seek to track and reward the performance of senior managers over time.

Other ideas in the vanguard of designing pay structures include “S-curves”, which pay less below a certain threshold of profit so as not to reward employees for market conditions and franchise value, but also pay out less above a certain threshold, to discourage excessive risk-taking. These types of thinking are likely to become more prevalent.”

 

This is all highly sensible.  However, it may not be as easy to implement as it appears.  As the Economist explains:

“Attempts to control pay in one area tend to inflate it in another. As bonuses fall, pressure on banks to increase basic pay is already rising. That pressure will grow as the industry recovers and competition for the best staff increases. ‘At some point in the next few years, the industry is going to have an absolutely stellar year,’ says a pay consultant who predicts that firms with clawback policies will have to offer more in upfront pay to attract recruits.”

 

This is why firms need me rather than a ‘pay consultant’!  We’re just not going to get anywhere if banks simply replace one flawed system with another.  The only way to do things differently, really differently (which is surely what’s required), is to replace the mindset that leads to the dysfunctional behaviour.  As I explained earlier:

“HR should never have let this situation develop.  And it's not just an issue of compensation design.  Some banks have refused to see their people as purely money motivated, but most have simply accepted their people are only engaged by high rewards, have offered these rewards, and have continued to recruit people who are motivated in this way.

But it hasn't had to be like this - there is no real reason why bankers need to be paid more that other sectors of the economy.  Not all talented people are money motivated and it's a shame that none of the banks ever looked outside this one stream of employees (leaving aside for a minute the question of whether they really needed talented people anyway ie whether less talented people may have taken more acceptable risks?).

The key for me, as I've posted before, is the banks' cultures.  Financial services firms need to offer their people a broad and balanced (financial and non-financial) EVP based on a compelling purpose (mojo) which is supported through HR practices including leadership development and succession planning etc.”

 

Of course, it’s going to take some guts to make this sort of change.  But at should at least be easier now than it was before – as the Economist reports:

“The traditional argument against changing pay structures has been that no institution could move unilaterally without competitors poaching its best people. Now, no bank can fail to alter its compensation policy without having its executives publicly humiliated by politicians and the news media, and frowned upon by regulators.”

 

The same argument applies to banks’ cultures / mindsets too.

 

 

Photo credit: Dennis Brown

 

 

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