19 January 2016

Banks should not be responsible for punishing former employees of competitors


The Bank of England has proposed new regulations that compel banks to impose financial penalties on the ex-employees of their competitors if they are found culpable for negligence or wrongdoing. Banks often attract talent from their rivals by buying out their unpaid bonuses, creating what the regulators see as a loophole. The proposals, however, are completely unenforceable.

In the wake of the financial crisis, regulators introduced various restrictions on how banks were allowed to pay their employees, including limits on the proportion of total remuneration that could come in the form of bonuses and requirements that bonuses be “clawed back” if it turned out that deals on which bonuses had paid later went sour. This was all with the intention to reduce excessive risk-taking.

Attention had turned to the ways in which bonus restrictions have encouraged staff to move on to new firms more quickly. Bonuses used to be an important device to keep staff in place until bonus day, since they’d forgo the bonus if they left earlier. But with new rules that limit bonuses to 33% of overall compensation, bankers’ base salaries have risen to compensate, and incentives to stay in place to get the bonus are reduced. Perversely, higher base salaries and lower bonuses have increased banks’ risk exposure in the event of a downturn.

But a new and more exotic problem has attracted regulatory attention. What happens if a bonus would be paid that might be clawed back, but then the staff member moves on before that bonus is received? Employees facing potential clawback have an incentive to switch companies if the recruiting bank offers new employees their expected bonus as a joining fee, and there is some tentative evidence that they are doing so. The Bank of England has indicated that it would like to close what it sees as a loophole by requiring new employers to enforce punishments demanded from old employers.

We’re clearly into theatre of the absurd territory here. The employee foregoes 100% of her actual bonus (let’s assume). So “clawing it back” never arises. How is anyone really supposed to confirm to what extent a joining bonus mirrors bonuses an employee would have received and might have been clawed back?  Suppose the new firm pays a straight (non-clawbackable) bonus that happens to be 85% of the bonus. Is that merely a joining fee or is it really a bonus buy-out that needs to be clawed back?

The whole concept is surely unenforceable without regulators getting into very detailed prescriptions about who can be paid what inside financial firms.  It also must surely favour larger firms with huge compliance departments over leaner less bureaucracy-heavy outfits who just want to concentrate on doing their jobs without keeping track of whether someone should have their bonuses clawed back from three employers ago.

There are many good reasons why banks and other companies pay bonuses: to create loyalty, manage cash flow, transfer risk to employees and to build esprit de corps.  Let firms decide how best to pay their staff and let the Bank of England decide how risky it thinks the banks’ assets are and whether it has adequate buffers.

Andrew Lilico is a political and economic commentator.