Tuesday, 9 February 2010

Banks, bonuses and bail-outs

Our leading bankers recently told the Treasury Select committee the usual story that unless large bonuses are paid, they will fail to attract or retain talented staff. This raises a number of questions.


Firstly, what sort of talent do the banks wish to recruit or retain? This, in turn, raises the issue of what is the fundamental purpose of banks? Are they:

• Normal business organisations that aim to maximise (or, at least, generate an acceptable level of profits) and thus may consequently suffer business failure in the competitive market? If this is the case then, by all means, pay bonuses that recruit or retain staff talent able to contribute towards profitability, but such individuals must also be in a position where erroneous decisions may lead to business failure and loss of employment. The banking sector would need to be restructured in such a way that bank failures will not lead to serious repercussions in the real economy. In other words, if banks are too big to fail, aren’t they just too big and should be broken up and forced to compete more fiercely with one another?

• Organisations whose primary role is to support the ‘real’ economy through the provision of credit to business? In such a situation the banking sector might be structured differently and banks may well become too big to be allowed to fail. Again staff bonuses would be acceptable to retain/recruit, but in this case bonuses should not reflect short-term bank profitability but the contribution the bank has made to business creation and sustainability.

Basically the banks can’t have it both ways. They can’t have a bonus culture that is based on corporate profitability, but then expect the banking system to be kept in such a way that they need government to bail them out when they make calamitous business errors. It has been said that the seeds of the next banking crisis are already being sown in the back offices of banks by people trying to earn large bonuses developing new products that may be profitable but also have high degrees of risk. The question is how to we stop this happening.

Moreover, why have we allowed banking and associated financial services to become such a hugely important part of our economy such that we effectively leave ourselves open to blackmail? The UK has a doubly asymmetric economy. Firstly, the over-emphasis on the financial services sector of the economy results in policies that inhibit other sectors of the economy. We are constantly told that the manufacturing sector in the UK now comprises just 12% of GDP but what it should also be pointed out that:

• the UK is the world’s sixth largest manufacturer measured by output

• manufacturing represents half of UK exports

• manufacturing has achieved 50% productivity growth since 1997

• manufacturing represents 75% of business research and development

• the UK is consistently in the top rankings of high-tech exports

• the UK has more foreign direct investment in manufacturing than any country apart from the USA.

Secondly, the UK economy suffers from a huge over-dominance of London and the Southeast (partly as a consequence of the scale of the financial sector) to an extent not seen in most other countries. This results in a two-speed economy, with the consequence that government sometimes introduces economic policies designed to damp down overheating in the Southeast but which have a negative impact on the rest of the UK economy.

It also generates huge distortions relating to other issues such as housing and transport. A more balanced economy, both in terms of sectors and regions, is essential to an effective recovery that is sustainable in the long term. Senior industrialists like Sir John Rose of Rolls Royce have consistently argued for the UK to develop further its manufacturing sector, but these messages seem to fall on the deaf ears of our London-based politicians and civil servants.

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