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Banks Fail to Align Bonuses With Risk Taking, Watchdog Says

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April 12 (Bloomberg) -- European banks are failing to align the calculation of employee bonuses with the risks they take, according to a study by the region’s top banking supervisor.

Lenders use “underdeveloped techniques” to link pay with risk-taking and lack consistent tools for selecting which workers should be subject to bonus regulations, the European Banking Authority said in a report on its website laying out the results of a survey it conducted.

The agency called on EU lawmakers to grant it powers to set criteria for identifying the risk-takers whose behavior the rules should target. The EBA said it noted “very high” ratios of variable pay to fixed pay. When bonuses dominate bankers’ compensation, “this could incentivize staff to take too much risk in order to assure a certain minimum pay level,” the agency said.

The EBA’s predecessor, the Committee of European Banking Supervisors, set bonus rules in 2010 that limited upfront cash payouts to about one quarter of the total bonus to ensure incentives were linked to the long-term performance of the firm.

Differences in how European Union member countries identify which risk-taking staff should comply “hinders the creation of a level playing field,” the London-based EBA said. “There is a clear tendency of institutions to select very low numbers.”

Lawmakers in the European Parliament may seek a ban on banker bonuses that exceed fixed pay as part of a draft law implementing the most recent Basel capital rules.

One-to-One

“We are looking at a set limit” on the size of bonuses compared to fixed salary, Othmar Karas, the lawmaker leading work on the rules, said at a meeting of the body’s economic and monetary affairs committee. This limit should be set at “100 percent, so one-to-one,” he said today.

Karas said he’s seeking a deal between the legislature’s different political groups as part of a compromise on the draft law. He had previously suggested finance workers’ bonuses be capped at twice their base pay.

Some bankers were receiving bonuses about 10 times larger than their base salary, according to the EBA survey. The median of the average ratios across all member states was 139 percent.

The ratios banks use to calculate variable pay versus fixed salary “tend to be high,” the EBA said in the report. “The criteria by which institutions decide on the ratios in practice are not always clear.”

Michel Barnier, the EU’s financial services chief, has said he is considering proposing extra rules on bonuses in response to payouts that go against “all reason, common sense and morality.”

To contact the reporter on this story: Ben Moshinsky in London at bmoshinsky@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net

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