Navigating the culture of bonuses in the financial sector

Former and current Governors of the Bank of England, Mark Carney and Andrew Bailey

When COVID-19 swept through Spain this spring, the country’s second largest lender, Banco Bilbao Vizcaya Argentaria (BBVA), wasted no time proving its social responsibility credentials. The bank announced on March 30 that its executives would forfeit their bonuses for 2020, worth an estimated 50 million euros ($56.26 million). “The international pandemic caused by the coronavirus is an unprecedented health crisis,” a BBVA spokesperson told World Finance. “As part of the measures taken by governments and monetary authorities to mitigate the impact of the pandemic on the global economy, financial institutions have a fundamental, if not exemplary, role in this crisis.”

This role has not always been a priority for the banks, which were largely responsible for the economic shock of the 2008 financial crisis. Since then, they have gone to great lengths to convince governments and the public that they have cleaned up . Regulation has also contributed to a more responsible banking sector, with the Basel III framework establishing bonus caps and high capital requirements as barriers to unbridled risk-taking. “A major effort has been made to improve ethical standards in the financial sector since the 2008 law [crisis]said William Blair, professor of financial law and ethics at Queen Mary University of London. “It is important that this work is not lost as we emerge from the pandemic.”

Of all the businesses affected by the COVID-19 outbreak, banks have been the most keen to show that they have learned the lessons of the global financial crisis. Bonuses have long been a point of contention in this conversation. Inciting high-flying bankers, the bonus culture has become essential in the world of finance. However, the coronavirus epidemic has caused some banks to abandon their old habits. Like BBVA, many institutions have announced that they will voluntarily waive these payments this year. Alison Rose, CEO of NatWest, will forfeit her bonus and has pledged to donate a quarter of her £2.2million ($2.76million) salary to a charity fighting coronavirus impact of the pandemic. Officials from Barclays, HSBC and several other UK banks made similar pledges, while Citigroup said it would offer a special $1,000 allowance to eligible employees in the US earning less than $60,000 a year.

Reputational concerns have partly influenced decision-making in these institutions. The BBVA spokesperson described the move to abolish bonuses as “a gesture of responsibility towards society, our customers, our shareholders and all our employees”. For those who have avoided this option, transparency will be key. “Companies will rightly have to defend their decisions and risk reputational damage if they cannot defend them as reasonable and appropriate,” Ian Peters, director of the Institute of Business Ethics, told World Finance .

For banks that received state support, whether through furlough schemes for their employees or loans and credit guarantees, the waiver of bonuses and dividends was a key measure. Charles Calomiris, professor of financial institutions at Columbia Business School, explained: “If the government is investing in a company to strengthen it in the public interest, that company should generally not be allowed to pay common stock dividends for that it receives financial support. , as it weakens the company’s financial position, dilutes the benefits of the assistance and exposes taxpayers to increased risk. »

The blame game
Regulators need to carefully consider how they approach bonuses. Outright bans may find favor with the public, but they hurt competitiveness and raise questions of fairness. Stephen Arbogast, professor of finance practice at the Kenan-Flagler Business School at the University of North Carolina, said: “During the [2008 financial crisis], the management of the banks was guilty of the crisis, so there was legitimate anger towards their management. It is not a crisis caused by malfeasance or negligence, so there is a big difference. Critics have also questioned the legitimacy of the measures, given that lockdowns have been imposed by governments, leaving banks in many countries no choice but to close their doors.

In addition, many financial services companies pay their executives relatively low salaries, supplemented by large bonuses, often in shares, to link performance and compensation. Banning bonuses can prevent establishments from attracting international talent. “State and business owner goals are aligned when bonuses are used to keep managers through a tough time,” Arbogast said. “They’re looking at their personal survival, and often in a situation like this they want to escape a sinking ship or someone comes along with a better deal.”

Regulatory responses to the pandemic have varied around the world. At the end of March, the Bank of England banned lenders from handing out cash bonuses and dividend payments. The announcement aroused the dissatisfaction of many institutions. HSBC was forced to suspend dividend payments for the first time since World War II, a move that has the company considering whether it should move to Hong Kong, where it makes much of its profits. However, the outbreak of the virus coincided with the end of the financial year when bonuses and dividends are traditionally paid out, meaning many UK banks had already given out their bonuses by the time the ban was imposed.

Of all the businesses affected by the COVID-19 outbreak, banks have been the most keen to show that they have learned the lessons of the global financial crisis

In Europe, where the bonus culture is less pronounced, the EU followed an even stricter approach that applied to all sectors. The bloc’s competition unit has relaxed state aid criteria to allow governments to support vulnerable businesses while barring top executives of those companies from receiving dividends and bonuses. Mergers and acquisitions were also capped at 10%.

Some countries went further, with France banning companies that received state aid from paying dividends to shareholders, following demands from the country’s powerful unions. In the banking sector, the European Central Bank (ECB) has ordered eurozone banks to cut dividends until October 1, a move that could free up 30 billion euros ($33.76 billion) to lend to borrowers affected by the pandemic. On the other side of the Atlantic, the US government has imposed strict restrictions on stock buybacks, dividends and executive compensation for companies using government support programs. However, no such restrictions have been imposed on banks, nor included in the Federal Reserve’s $500 billion corporate bond purchase program.

above the board
The pandemic has also reignited debate over whether governments should take equity stakes and sit on the board of bailed-out institutions. While US President Donald Trump has endorsed the idea, Arbogast argues that this approach needs to be executed thoughtfully, given the nature of the current recession: “If the government is strapped for resources and seeks to provide in the most capital-efficient way, there is reason to make the case for equity participation. However, there is no need to participate in the management. The institutions involved are not responsible for this economic downturn and no cleanup is needed.

Share buybacks are an equally contentious issue. Critics allege the practice is commonly used to artificially inflate stock prices, diverting cash from other activities. The ECB has ordered eurozone lenders to refrain from share buybacks this year, while Trump has expressed an interest in banning companies that have received state aid from the practice. In an act of pre-emptive self-defense, some of the biggest US banks, including JPMorgan Chase and Bank of America, froze buyback programs until the end of the second quarter of the year. “If you voluntarily accept state aid and continue to buy back shares, you are essentially passing that money on to your shareholders,” Arbogast said. “I think there is a serious problem with that.”

The decline of the bank bonus culture could be one of the lasting side effects of the pandemic. With remote working becoming an increasingly attractive option for bankers, a better work-life balance could erode the importance of financial bonuses. Automation can also contribute to this culture change by limiting the role of risk takers in financial institutions, and therefore their right to high bonuses. According to the BBVA spokesperson, internal surveys carried out by the bank showed that most of its employees “valued very positively the possibility of having more flexible working opportunities, combining remote and face-to-face work”. . They continued: “This crisis has accelerated the trend towards new forms of work. [Our] employees have already named this option as one of the most popular benefits.

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