Business Standard

Predictable bank response

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Peter Thal Larsen Nicholas Paisner

UK bonus tax: Alistair Darling appears to have failed. The UK Chancellor of the Exchequer thought his "super tax" on bonuses would force banks to shrink their payouts. But even punitive taxation and widespread public anger have not dissuaded banks from preparing to distribute large bonuses for 2009. The UK tax appears to be simply another cost of doing business.

This is depressing, but predictable. Most investment banks operate global bonus pools and attempt to equalise pay for similar employees regardless of where they work. As a result, it is hard to slash bonuses just in the UK. Banks fear that if they do what Darling wants, some rivals will not. As a result, all banks will pay up.

 

This outcome is embarrassing for the UK government, but it comes with a silver lining. If banks press ahead with their bonus plans, tax revenues will be much higher than expected. Indeed, 50 per cent of Goldman Sachs's UK bonus pool alone would probably more than cover the £550 million that the Treasury expects the tax to raise.

Big bonus payments are also bad for financial stability. As the Bank of England points out in its Financial Stability Report, UK banks could add £70 billion to capital over the next five years if they cut compensation by 10 per cent and reduced the amount they pay out in dividends by 30 per cent.

The more pressing question is how the costs of the bonus tax are distributed. In principle, banks should really deduct the extra UK tax from the total bonus pool. That way, the cost is spread across their global workforce. The danger, however, is that banks will stop rebuilding capital instead. This would be a truly perverse outcome. Regulators must not allow banks to use the UK tax as an excuse for rethinking their capital plans.

Investors, meanwhile, should also be on their guard. The danger is that they will bear the burden in the form of lower dividends. Banks will no doubt argue that slashing bonuses would put them at a competitive disadvantage and would ultimately hurt shareholders. But investors should stand firm. Shareholders in investment banks have historically been the junior partners to employees. Now is a good time to start redressing the balance.

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First Published: Dec 19 2009 | 12:37 AM IST

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