Banks blind to compensation risks?
The Dodd-Frank act is having profound effects on the the banking business. Prop desks and internal hedge funds are being spun out. Derivatives trading departments are scrambling to prepare for central clearing. But one very imp
ortant fact of the banking business has survived all efforts at reform: high compensation.
Analysis by the Financial Times shows that no major broker-dealer achieved ROE of 15% in the fourth quarter of last year. How does ROE range from a paltry 5% to 13% for the banks studied? It’s the compensation, stupid. The FT estimates that banks wouldhave to cut annual pay 16% to 39% to get ROE to 15%.
Think that’s bad? Consider this: a new study by Deloitte found that only 37% of financial institutions it surveyed incorporated risk-management factors into their compensation and bonus plans in a meaningful way.
Think that’s bad? Here’s the kicker: a new study shows that investment banks are lagging other financial firms in developing separate pay models for their chief risk officers. In summarizing the study, the FT writes that “there was little consistency among investment banks, in spite of a growing consensus that CRO packages should be de-linked from short-term profitability and provide much more limited opportunities for bonus payments.”
Compensation is at the core of the single largest threat to their reputation faced by large banks. The FT has an annoying habit of fixating on an issue and writing about it at every opportunity. The banker pay stories linked here appeared within 10 days of each other. Watch for more.
Consensus is that banking reform has not done much to end concerns that institutions are too big to fail. If we find ourselves in another banking crisis and taxpayer dollars need to be used to bail out what are perceived to be “Wall Street fat cats,” voters will demand more drastic change.
The rising economic tide has lifted banks higher than most, but because of pay structures, danger could be lurking.
Update: Don’t look now, but the SEC has proposed it be empowered to ban excessive bank bonuses.