Surface Ripples

Bashing The Bankers, Again...

Almost two years after the current crisis began, we continue to tinker with the system. Why is it taking so long to fix?

The UK government has announced that the FSA will now monitor remuneration packages to ensure that they do not encourage "excessive risk-taking". So the FSA has now become the remuneration committee of the UK financial system in addition to its remit of ensuring financial stability and prudence. The report is short on detail of how this will be achieved, however, as it is difficult to tell where a package that rewards a CEO for good stewardship begins and ends. The whole raison d'etre for banks is taking risk. Some of them just did it better (or were luckier) than others.

We are now at a stage where it is socially (and, it would seem, morally) reprehensible for a CEO charged with sorting out the problems in a government-rescued bank to be rewarded for his efforts. I am talking here about the anger over the GBP9.6million package of Stephen Hester who has stepped into the thankless role of Chief Executive at RBS. Would things be the same if he had stepped into rescue a large UK corporate other than a bank? The question is more, is GBP9.6million too much? If he saves the UK government (and, by extension, the taxpayer) billions, this may be a small price to pay. The labourer is worthy of his hire... Much of Mr. Hester's package is actually in the form of deferred share options, meaning that he doesn't get them unless certain conditions are met.

The general thrust is right in that the Chancellor is trying to return to the concept of "fiduciary" duty of bankers toward their clients. This means that a "good" banker may have to decline to sell a product to a client if it is not in their best interests. However, that same banker should not be held accountable for meeting ever-increasing profit growth targets as these may be diametrically opposed to what constitutes "good" banking. Here is where the interests of shareholders (who want capital appreciation and dividends) and customers (who want safety) differ. It is this difference which needs to be managed carefully. We have seen top management have their rewards cut for their role in getting RBS into its current mess, but shouldn't the person who gets it out deserve to be rewarded for that as well?

We need to change expectations right down the line and this involves a serious re-think of what CEOs are for. Senior management run a company for the benefit of the shareholders who want a return (dividends) on their investment and for the value of that investment to grow (capital apreciation). The shareholders are the ones who vote the top management in (and out), and therefore their wishes are paramount. Shareholders who wield the most influence these days are the large institutional fund managers - pension funds, insurance companies for example - who own billions of shares and therefore have a major say. Is it not up to them to reign in errant CEOs? Of course, their comment would be that they trusted the CEO and Board... The 2007 Annual Report of RBS details major shareholders and makes for interesting reading, as some would definitely have had the expertise to question RBS' strategy.

Banks are different to other industries, as they are the bedrock on which confidence in the financial system is based. If that confidence is lost, chaos ensues (as we saw with Northern Rock). Banks are there to take deposits, to lend to those in need, to sponsor sporting events, to sponsor charity events, to provide safe and stable employment. The number of comments on what is expected of Mr. Hester in the article above just shows how many different stakeholder interests there are in RBS.

Perhaps banks cannot be trustworthy guardians of our financial safety and hugely profitable if the latter depends on taking huge risks. Once this is understood, we have a basis on which to begin. Similarly, it may mean that they will no longer lend to those who cannot repay. This will mean lower profit margins, lower deposit rates, and people who can no longer purchase goods and services on credit, with its attendant impact on the economy. For higher-risk lending, higher rewards and higher capital are the only way to go.

Banks embarked on one of the most ill-advised personal lending sprees during the first few years of the millenium, and the global economy and the taxpayer will be paying for this for many years to come. Banks were turned into "financial supermarkets" run by people who were in some cases not themselves financiers by training. There is little doubt, however, that a lot of the growth that the global economy saw during the same period was also due to the banks being prepared to take risks - and noone saw fit to complain whilst the going was good. Whether the organisation charged with maintaining confidence in the UK financial markets should get into the details of their compensation is a different matter.

Labels: Financial

posted by William Martin @ 02:24