That trade might not pay off until the next decade.

Careful How You Constrain Banker Bonuses

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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The drive to impose tighter regulations on the banking industry is understandable. As the global economy still struggles to recover from the financial crisis, the revelations keep coming that bankers manipulated just about every number that ever crossed their abacuses. Some of the proposed rules, however, have more to do with fear and revenge than making the banking industry work well.

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Yesterday, HSBC Holdings Chairman Douglas Flint, who pays attention to the way rules can have unintended consequences, made two observationsthat should give regulators pause.

His first point was aimed at the suggestion that banks should defer their employees' bonuses for several years, and if need be claw them back if they turn out to have been earned unfairly. Flint pointed out that while this strategy helps protect against "excessive risk taking," it also makes it almost impossible to recruit people from outside the banking industry:

When you say to someone in the tech industry that you'd like them to join banks to help with cyber risk, and say your money will be paid in seven years' time, it's an easy conversation -- they decline to consider it.

I'm pretty sure most of us would howl with outrage if our employers suggested chipping our annual income into chunks to be distributed piecemeal in the coming years. And any company that did would swiftly fall off most people's list of places they'd like to work.

A better way to regulate bonuses so that they don't incentivize short-term thinking and gambling is to make them more akin to royalty payments -- by tailoring them to the transactions they're meant to reward. If that's a one-off trading profit in the currency market, the size of the bonus should reflect the risk that the trade might turn out to have gone wrong; if it's generated by an investment banking deal for which the benefits accrue gradually over years, then the bonus should pay out more slowly.

Flint's second point, made to a House of Lord's committee on financial affairs, concerns geographical jurisdiction. A bank headquartered in Europe, Flint said, finds itself hamstrung by the European Union in how it pays employees around the world. "I was disappointed to see it regulate remuneration globally," he said.

The EU has moved faster than authorities elsewhere to introduce rules constraining bonuses; it shouldn't follow that a bank such as HSBC can't compete with its rivals in Asia or the U.S. in choosing how to pay its staff. Regulators around the world need to move cooperatively, or financial firms will be tempted to follow their corporate tax-avoiding brethren in relocating their headquarters.

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

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Mary Duenwald at mduenwald@bloomberg.net