The problem with

3rd October 2012

Banks are moving to make their bonuses systems more acceptable as the high level of bankers' remuneration continues to anger the public – aiming to use rewards to encourage better customer service and greater public responsibility.

Stephen Hester says Royal Bank of Scotland's bonus structure could be overhauled to have a greater focus on customer service. The chief executive, who was speaking at the London School of Economics, made the suggestion when recommending a new "compact" between banks and society.

"Now our reform agenda has to go further so that pay also takes proper account of the customer interest. That means pay awards must be reflective of improvements in customer service and satisfaction and not just sales," the Guardian reports Hester as saying.

RBS is not the only bank working to amend pay structures in a bid to improve public image.

New Barclays chief executive Antony Jenkins wants the bank to look at rewarding employees based on a new "balance scorecard" – which includes looking at how their actions affected customers, investors, other employees, society and other stakeholders, Reuters reports.

At the Clinton Global Initiative last month, Jenkins said the new method of measuring performance will allow the bank to meet its aim of "becoming a source of good" for society at large.

A cynic might note that the above banks have been in the public eye for the wrong reasons of late, both having been implicated in the Libor scandal. In addition, the issue of bonuses is never far from the debate on banks and their societital responsibilities.

The bonus culture has been widely blamed for exacerbating the financial crisis, by encouraging excessive risk-taking in pursuit of short-term rewards. Would tying bonuses to socially responsible behaviours make bankers channel their efforts into "becoming a source of good" and not just profit?

Well, Barclays' idea of measuring an individual's impact on all stakeholders is certainly laudable – but how in practice can this be achieved?

There would be obvious difficulties, for example, in working out how one employee has affected the environment or weighing up the interests of their fellow workers against the whole of society.

Looking at RBS' plans, again there are questions over how the effect an individual can have on the customer service offered by the organisation can be accurately gauged. Also, how can the customer service of certain divisions, say their investment arms or their accountancy teams, be a constructive element of any bonuses.

If there's a risk that poor practice on an individual could be overlooked, then we're still left with the risk of the bad behaviour seen in scandals such as Libor fixing.

Also, some academic evidence disputes that bonuses encouraged risky behaviour on an individual level in the first place. Research carried out last year by Nottingham University Business School suggests the evidence does not support the alleged connection between bonuses and risk.

After analysing the bonus arrangements of the top 40 UK-based financial services firms, the researchers determined that a business' overall profitability has more impact on bonus levels than an individual's performance.

Alistair Bruce, professor of decision and risk analysis, says: "There now appears to be a growing realisation that changing the incentives inherent in pay structures is not the answer to moderating risk appetites.

"Rather, addressing risk management in the banking sector directly – for instance, by increasing banks' capital requirements in terms of capital ratios – is the key."

Given the financial services' use of bonuses seems to have failed to lead to the desired aim of improved performance, a convincing argument can be made that similar failures to promote socially useful actions would follow – and risk would still be there.

London Business School associate professor of strategic and international management Freek Vermeulen calls for the banking industry's whole bonus system to be overhauled.

Vermeulen argues that bankers' bonuses are not intended to act as a reward for good performance – rather they are a form of flexible pay than can be scaled up or down in line with the bank's profits.

He also draws attention to the inefficiencies of the current bonus system, claiming that it fails to motivate employees, emotionally connect them to their firm and improve retention. "Guaranteed bonuses" have even less success, he notes.

"Thus, rather than being immoral and unethical, the bonus system is simply rather crude and clumsy; it does not get the job done. That is not unusual for banks, which generally seem to be run by people who are excellent bankers but very poor at managing stuff," Vermeulen concludes.

"Common sense would suggest that they rethink the bonus system's name (and change it into something like flexible pay). Scientific evidence would suggest that they rethink the set-up of the entire system altogether."

Bonuses appear to have little impact on behaviour – be that positive or negative actions. Bankers take risks because they're in an inherantly risky business, it seems.

Writing in the New York Times late last year, The Black Swan author Nassim Nicholas Taleb argues for the complete abolition of bankers' bonuses.

"What would banking look like if bonuses were eliminated? It would not be too different from what it was like when I was a bank intern in the 1980s, before the wave of deregulation that culminated in the 1999 repeal of the Glass-Steagall Act, the Depression-era law that had separated investment and commercial banking," he says.

"Before then, bankers and lenders were boring ‘lifers'. Banking was bla
nd and predictable; the chairman's income was less than that of today's junior trader. Investment banks, which paid bonuses and weren't allowed to lend, were partnerships with skin in the game, not gamblers playing with other people's money."

 

More on Mindful Money:

Is it all bad news for the financial services industry?

New Statesman fails macroeconomics 101

Banking Crisis – Have the lessons finally been learnt?

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