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On The Bright Side, European Banking Bonuses May Be A Lot More Predictable

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It's probably good news that "European Union finance ministers reached a landmark deal early Thursday that would bring many of the continent's banks under a single supervisor," but of course it wouldn't be Europe without some self-evidently bad ideas for financial regulation, so today we also get this:

Bankers’ bonuses in Europe would be capped at two times fixed salary under a tentative EU agreement that would mark the most severe crackdown on pay since the 2008 financial crisis.

The European parliament and negotiators for member states drafted a deal in Strasbourg on Thursday that imposes a 1:1 bonus to salary ratio, which can be increased to 2:1 with the backing of a supermajority of shareholders.

Still being negotiated, can change, etc. One could perhaps imagine that once there's a single eurozone banking supervisor, the warm glow of supervision will shield eurozone banks from this sort of chaotic meddling from the European parliament. Or not, who knows.1

This is mostly bad for the usual reasons: keying bonuses to base salary, without capping base salary, increases fixed costs and thus risk, while reducing bankers' incentives to actually do a good job at whatever they're supposed to be doing. A first-best comp scheme would probably involve huge bonuses to reward bankers for doing the things you want them to do; smaller bonuses is perhaps a better scheme than huge bonuses to reward bankers for doing the thing you don't want them to do, but it's not a particularly impressive approach.

But as Bloomberg puts it, Europe is on "a quest to reshape lenders as utilities rather than money-making machines.2" I suppose the idea is that when bonuses are capped, the ambitious people who were working long hours at banks to earn big bonuses will quit and go elsewhere, leaving their jobs to less aggressive people who will work shorter hours, try less hard, and be happy to collect their fixed pay. The less ambition, and hours, devoted to banking the better, the Europols might reasonably think.

Which makes the shareholder vote weird, no? Shareholders moan about comp being too high, but you'd have to guess that most European banks will be able to get the required shareholder approval to pay bonuses of 2x base salaries rather than 1x. The proxy could read "we can (1) allow bonuses of 2x base or (2) raise everyone's base by 50%, choose one." And shareholders aren't just, like, financially literate and aware that they'd rather have fewer fixed costs: they also tend to have some fondness for the sort of ambitious, hard-working, risk-taking types whom big bonuses attract. The usually mentioned structural problems of banking's bonus culture - short-termism, excessive risk-taking, high upside without full downside participation - are also features of the equity markets. Bankers and their shareholders are, broadly speaking, pretty aligned.

If Europe wanted to regulate bonuses by interested-stakeholder approval rather than random Brussels whim, why not let bondholders - or holders of cocos or bail-in-bonds - vote to approve pay packages? They see considerably less of the upside when bankers take crazy risks that work out, and considerably more of the downside when the risks don't work out. And they tend to be temperamentally more conservative than financial-industry equity investors. Aligning bankers less with their shareholders and more with their debtholders might be a good idea.

Of course that's based on actually existing financial-industry equity investors. Utilities shareholders are a lot like bondholders: conservative, interested in a stable price and a steady yield, not looking to take risks. If bank shareholders do turn down banks' efforts to increase bonuses, that will be a good sign that the utilityification efforts are working.

EU Reaches Deal on Bank Supervisor [WSJ]
EU set to cap bankers’ bonuses [FT]
Banker Bonuses Seen Capped at Twice Salary in EU Compromise [Bloomberg]
In Defense of the Wall Street Bonus [DI / Kevin Roose]

1. Ooh, also: "The draft terms … would apply to all banks operating in the EU." Just for employees in the EU, d'you think? Europe is a little less into extraterritorial enforcement of its hobbyhorses than the US is, but I'd sort of like to see them try to tell Goldman that it can't pay its New York bankers bonuses.

2. The "rather than" is perhaps inelegant. Utilities that operate money-making machines. More reliable money-making machines. I mean banks are pretty much literally money-making machines; that's the core of their public utility function. It's just there's another part of their function that is like making scary structured products or what have you.