DIVIDEND AND BONUS CUTS WOULD HAVE AVOIDED BAIL-OUT

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Bank of England
Bank of England: cut back on cash bonuses.

There can’t be a single member of the public who hasn’t worked out that, if banks had been as prudent over recent years as they always tell their customers to be, they wouldn’t have needed to come to the tax-payer for a bail-out. But now it’s official!

A 20% cut in pay and dividends from UK banks in the boom years would have raised more than the money pumped in by taxpayers during the financial crisis, the Bank of England has said in its December 2009  Financial Stability Report. The bank said the cut in ‘discretionary distributions’ between 2000 and 2008 would have generated an extra £75 billion – more than the £66 billion injected by the state.

Between 2001 and 2006, banks were paying out almost a third of revenues in staff costs and 46% in dividends, according to the report, which went on to say that, going forward, a 10% cut in pay and a one-third reduction in dividends could raise £70 billion over the next five years.

Pay incentives in shares

And the central bank warned the industry to cut back on excessive cash bonuses, with a preference for incentives to be paid in shares.

‘Given the scale of the challenge facing banks in rebuilding their balance sheets, they would benefit from distributions from reserves being materially lower than in the past, or paid in a non-cash form (shares) which retains equity within the business,’ it said.

These comments are likely to add more fuel to the debate raging over banking pay following the chancellor’s one-off tax on bonuses announced in last week’s Pre-Budget Report. This is expected to raise some £550 million.

The report added that ‘relatively modest limitations in the distribution of profits’ would help banks meet capital requirements without shrinking their balance sheets. It also warned that if banks instead choose to cut back on lending, ‘it could undermine the recovery from recession and ripple back to banks’ balance sheets through higher loan losses’.

Too-important-to-fail culture

The report stresses that, ‘in the medium term, the root causes of this and previous systemic crises must be tackled – excessive risk-taking in the upswing of the credit cycle and insufficient resilience in the subsequent downturn’.

It warned: ‘An expectation that “too-important-to-fail” firms will receive public assistance, and that unsecured wholesale creditors will not share losses, has exacerbated both the boom and the bust. That calls for a robust, multi-faceted policy response. Regulatory policies should give greater emphasis to systemic risks over the cycle and across institutions, as set out in a recent bank discussion paper. They should be complemented by structural measures to contain the spread of risk across the system.’

And it seems that, in future, institutions won’t be able to rely on the tax-payer to bail them out. The bank stated: ‘Because failures of financial institutions cannot and should not be prevented, the resolution framework will need to be improved to limit the impact on the wider economy.’ In future, it seems, the authorities don’t aim to be caught napping.

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