Don't be too hard on Osborne: the bonus cap is horribly flawed

What will happen to bankers pay? Very little. To their risk taking? Very little. To, basically, anything? You guessed it.

In opposing the EU's cap on bankers' bonuses, George Osborne isn't just giving nakedly preferential treatment to the city. The chancellor does have some strong arguments on his side as to why the cap is a bad idea.

To recap, late on Wednesday, the EU parliament secured agreement to impose a mandatory 1:1 ratio of salary relative to "variable pay". That ratio can rise to 2:1 with shareholder approval (subject to 50 per cent quorum), but no further. Britain still has the option of pushing the move to a vote, but that would cross a rubicon in UK-EU relations: in the past, Britain, commonly an outlier in matters of banking policy, has pushed negotiations to the brink of formal vote and then taken a few ceremonial trade-offs in return for its approval. That way, it can truthfully say it has never been overruled by the EU.

Not only would forcing a vote we would definitely lose play terribly politically — George Osborne making his biggest-ever stand in the EU over the right of bankers to be paid exorbitant sums — it would also be a gift to the anti-EU wing of the conservative party, of which Osborne is, thankfully, not a member.

But while he shouldn't force a vote, the Chancellor has good reasons for being wary of the policy. There are three big concerns, two of which are legitimate, and two of which are shared by the chancellor (although not the same two).

The first is that the policy will do nothing for equality. Despite the fact that the cap on bonuses is sometimes phrased as tackling "high pay", it will, in all likelihood, increase pay. As Deborah Hargreaves writes:

Already base salaries in the banking sector have been rising sharply as regulators try and choke off the multimillion-pound annual bonus awards. The EU's plan could lead to more pressure for a rise in fixed pay.

Banks have increased salaries across Europe by 37% in the past four years in response to a crackdown on bonuses and pressure from regulators to claw back some rewards if bets go wrong later on.

The reasoning is fairly obvious. If you cap bonuses at the same level as salaries, and put no limit on salaries, it's clear what's going to happen.

Of course, that's fairly unlikely to be a motivating factor in Osborne's reasoning. If there's one thing the Conservatives are comfortable with, it's people getting filthy rich (although they seem to quietly ignore the "as long as they pay their taxes" part of Peter Mandleson's famous phrase). But it's an important argument against the bonus cap overall.

Not such a strong argument is that banks might flee the EU to avoid it. There is certainly going to be some pressure, because the cap has overreached such that it also affects international operations of EU-based banks. The name being bandied around is Standard Chartered, the London-based firm that does most of its work in emerging markets (back in the news at the moment over it's £110,000 fine in Taiwan). But the cap can't be both easy-to-evade and a motivation to spend time and money moving headquarters, and all indications are that it's the former rather than the latter.

But the biggest problem with the bonus cap is that it won't do anything to address the most important reason for its introduction: tackling risk in the banking sector. The model Osborne and the UK proposed instead was likely to be better in that regard: "our" desired cap would only hit cash bonuses. That would provide an incentive on banks to award increasing chunks of their pay pool in the form of stock options and the like, which encourage bankers to act in the long-term interest of their company, not merely boost their returns for that year to enhance their bonus.

In fact, it's questionable whether bonuses even encourage must risk-taking at all. Crooked Timber's Dan Davies demonstrates that, assuming a bonus is linearly related to performance, the bulk of the bonus encourages very little risk taking at all. Employees have a motivation to take risks if their performance is poor enough that they would get no bonus, but once they have some bonus, every further risk they take is as likely to decrease their income as it is to increase it.

Maybe, as the Guardian suggests, the bonus cap was worth it just to make bankers publicly admit that their high pay has little to do with their actual ability. But for any genuine policy aims, it seems unlikely to be as successful as its promotors hope.

Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Commons Confidential: Fearing the Wigan warrior

An electoral clash, select committee elections as speed dating, and Ed Miliband’s political convalescence.

Members of Labour’s disconsolate majority, sitting in tight knots in the tearoom as the MP with the best maths skills calculates who will survive and who will die, based on the latest bad poll, observe that Jeremy Corbyn has never been so loyal to the party leadership. The past 13 months, one told me, have been the Islington rebel’s longest spell without voting against Labour. The MP was contradicted by a colleague who argued that, in voting against Trident renewal, Corbyn had defied party policy. There is Labour chatter that an early general election would be a mercy killing if it put the party out of its misery and removed Corbyn next year. In 2020, it is judged, defeat will be inevitable.

The next London mayoral contest is scheduled for the same date as a 2020 election: 7 May. Sadiq Khan’s people whisper that when they mentioned the clash to ministers, they were assured it won’t happen. They are uncertain whether this indicates that the mayoral contest will be moved, or that there will be an early general election. Intriguing.

An unguarded retort from the peer Jim O’Neill seems to confirm that a dispute over the so-called Northern Powerhouse triggered his walkout from the Treasury last month. O’Neill, a fanboy of George Osborne and a former Goldman Sachs chief economist, gave no reason when he quit Theresa May’s government and resigned the Tory whip in the Lords. He joined the dots publicly when the Resolution Foundation’s director, Torsten Bell, queried the northern project. “Are you related to the PM?” shot back the Mancunian O’Neill. It’s the way he tells ’em.

Talk has quietened in Westminster Labour ranks of a formal challenge to Corbyn since this year’s attempt backfired, but the Tories fear Lisa Nandy, should the leader fall under a solar-powered ecotruck selling recycled organic knitwear.

The Wigan warrior is enjoying favourable reviews for her forensic examination of the troubled inquiry into historic child sex abuse. After Nandy put May on the spot, the Tory three-piece suit Alec Shelbrooke was overheard muttering: “I hope she never runs for leader.” Anna Soubry and Nicky Morgan, the Thelma and Louise of Tory opposition to Mayhem, were observed nodding in agreement.

Select committee elections are like speed dating. “Who are you?” inquired Labour’s Kevan Jones (Granite Central)of a stranger seeking his vote. She explained that she was Victoria Borwick, the Tory MP for Kensington, but that didn’t help. “This is the first time you’ve spoken to me,” Jones continued, “so the answer’s no.” The aloof Borwick lost, by the way.

Ed Miliband is joining Labour’s relaunched Tribune Group of MPs to continue his political convalescence. Next stop: the shadow cabinet?

Kevin Maguire is Associate Editor (Politics) on the Daily Mirror and author of our Commons Confidential column on the high politics and low life in Westminster. An award-winning journalist, he is in frequent demand on television and radio and co-authored a book on great parliamentary scandals. He was formerly Chief Reporter on the Guardian and Labour Correspondent on the Daily Telegraph.

This article first appeared in the 27 October 2016 issue of the New Statesman, American Rage