Bank of England official Andrew Haldane said lenders should change how they calculate performance-based pay for executives and end the “equity dictatorship” that pushes them into excessive risk taking.
“The risks from banking have been widely spread socially, but the returns to bankers have been narrowly kept privately,” Haldane said in a speech in London late yesterday. “That risk-return imbalance has grown over the past century. Shareholder incentives lie at its heart.”
Haldane’s comments came as campaigners in London set up a second camp in Finsbury Square in the city’s financial district inspired by anti-Wall Street protests in New York and other cities. Haldane, citing the cost of bank bailouts after the financial crisis, said “fundamental reform” is needed before banks’ incentives are “properly aligned with the public good.”
“If you look at those occupations in Wall Street or Finsbury Square” and elsewhere in the world, “those risks are still being felt today,” Haldane said, straying from the text of his speech. “If we are fortunate, those bills will be paid by our children, if we’re unfortunate, they’ll be paid by our grandchildren.”
Haldane, the central bank’s executive director for financial stability, said new capital rules don’t go far enough and he proposed measures to reduce excessive risk taking, including the use of so-called contingent convertible securities and improving governance at banks.
Haldane said the “behavior” of the financial system would be “improved” by changing how executives’ salary is calculated from return on equity to return on assets. He noted that the salaries of the chief executive officers of the seven largest U.S. banks rose from 100 times the country’s median household income in 1989 to 500 times in 2007.
Banks currently operate under an “equity dictatorship,” according to Haldane, where ownership and control is in the hands of a “small minority.” Interests may be better served by extending voting rights “across a wider set of liability stakeholders,” he said, adding that governance “would then be distributed across the whole balance sheet.”
“It is the ultimate irony that an asset calling itself equity could have contributed to such inequity,” Haldane said. “Righting that wrong needs investors, bankers and regulators to act on wonky risk-taking incentives at source.”
On CoCo instruments, which convert into ordinary shares if a trigger event occurs, Haldane said this trigger should be “set well ahead of default to avoid its deadweight costs.”
It “needs to be an early health scare for a bank, not the last rites,” he said.
If such a policy had been in place before the financial crisis, the last few years may have “played out differently. Pre-emptive recapitalization of failing institutions would have occurred,” Haldane said.