For Better Banks, Banish Those Bonuses

If you believe paying large bonuses to executives makes a bank more competitive, consider this: Two of the world's safest banks refuse to pay their top staff any bonuses at all.

If you believe paying large bonusesto executives makes a bank more competitive, consider this: Two of the world's safest banks refuse to pay their top staff any bonuses at all.

For decades, there was just one such bank -- Sweden's Handelsbanken, which gave up bonuses in 1973, introducing instead a profit-sharing scheme that promised a cash payout only when a participant turned 60. It was lonely out there in no-bonus land until this week, when Dutch Rabobank announced the abolition of variable pay for its executive board.

Bankers' bonuses are a hot political issue. The U.K.'s Chancellor of the Exchequer, George Osborne, has sued the European Union over the planned introduction of a bonus cap in 2014. The measure would limit variable pay to twice base salary, subject to shareholder approval and provided that at least 40 percent of the bonus is deferred three to five years, with the bank having a "clawback right" to keep the money if performance worsens over that period. The cap would affect all bank employees whose total compensation exceeds $680,000 per year.

French, German and Italian advocates of the cap say it will reduce the incentive for bankers to take unnecessary risks. The U.K. counters that bankers, a mercenary breed, will just go where there is no cap -- to hedge funds and banks in the U.S. and emerging markets. That will deplete London's banking talent and turn the global financial center known as the City into a backwater ruled from Brussels.

The U.K. argument does not hold water. According to a recent paper by Kevin J. Murphy of the University of Southern California, the median ratio of bankers' variable pay to fixed pay was 1.5 in the EU and 9.3 in the U.S. in 2011, yet European banks remained globally competitive. And then there are the examples of Handelsbanken and Rabobank.

Handelsbanken chief executive, Paer Boman, received a fixed salary of $1.7 million and benefits worth some $60,000 in 2012. Handelsbank managers may not be rock stars - at least they are not paid as if they were - they do a good job.

Handelsbanken, number 22 on Global Finance magazine's list of the world's safest banks and number 11 on Bloomberg's list of the world's strongest banks, boasts a return on assets of 0.6 percent in its latest fiscal year, compared with an average of negative 0.4 percent for 28 banks in the Euro Stoxx Financials index. A no-nonsense, old-fashioned bank with a low appetite for risk, it has nonetheless gained a large international presence, with 770 branches in 24 countries.

Another conservative institution with a focus on agricultural lending and retail, Rabobank pays its managers well: The five executive board members made a total of $15.6 million in 2012, just $272,000 of which was performance-related. Rabobank is 28th largest bank in the world by assets, on which it generated a return of 0.3 percent in fiscal 2012. It is also the 10th safest, according to Global Finance. Like Handelsbanken, it required no government aid during the crisis.

Bonus-cap opponents say a focus on fixed salaries, which are already going up across Europe in anticipation of the cap, makes a bank more vulnerable to business cycles and downturns. The examples of Handelsbanken and Rabobank show that is not necessarily the case. Both institutions focus on commercial rather than investment banking, and make plenty of money without getting deeply involved in fancy derivatives. Regulators may be forgiven for pushing banks towards their behavior model by severely restricting bonuses.

If the restrictions stand and tighten, "stars" motivated by huge amounts of variable pay will leave the sector, and may ultimately make it even more necessary to regulate "shadow banking," the funds and other entities that now play as large a role in the financial system as traditional banks. Banking will once again be the domain of conservative, moderately creative people whom customers can actually trust. As Bank of England governor Mark Carney pointed out, trust arrives on foot but leaves in a Ferrari.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.