Adair Turner, Britain’s top financial regulator, laid out the proposed new powers that he and some of his international colleagues hope to wield to ensure that bankers’ bonuses do not rely solely on the pursuit of profit.
Not only will regulators insert themselves into the secretive realm of bank compensation practices, Mr. Turner said, they will also demand that banks set aside more capital if their pay packages are too high.
“This has never been done before,” said Mr. Turner, who heads the Financial Services Authority in Britain. “But the days of light-touch regulation are over.”
Mr. Turner made the remarks in an interview before a speech at the Cass Business School in London this week.
The main theme of his speech was a call for banks to hold more capital to guard against future losses.
But buried in the fine print was the outline of a new global approach to regulating bankers’ compensation that represents a direct challenge to practices at the heart of the British-American financial model. If put in practice, the policies could fundamentally change the way Wall Street and London’s financial district, the City, operate.
Amid the uproar over bonuses at the American International Group and Merrill Lynch, the question of how bankers are compensated has never been more hotly debated. A similar debate has erupted in Britain over the pay practices at a number of major banks, not just those that have received government bailouts but others, like Barclays, that have not.
Although Mr. Turner’s remarks focused on Britain, in recent weeks a small group of senior regulators, central bankers and government officials working under the framework of the Financial Stability Forum have been preparing a proposal that they hope will be endorsed by political leaders at the coming Group of 20 summit meeting in early April.
Prepared by a panel headed by Philipp Hildebrand, the vice chairman of the Swiss National Bank, the report will effectively back the financial authority’s approach to pay. It proposes that national regulators ensure that compensation awards at financial institutions are based not just on profitability but also on the extent to which a trader or banker did not take excessive risk in order to generate high returns.
Deferred payout plans and clawback measures would also be proposed.
“The system is dysfunctional now, so you need something to break the pattern,” said Gary Lutin, an investment banker and public critic of executive compensation levels.
Still, he said, it is one thing for regulators to promise to crack down on pay and quite another for them to actually do it.
Traditionally, the Securities and Exchange Commission in the United States and the Financial Services Authority in Britain — both of which contributed to the report — have supervised areas like capital adequacy and broad compliance with securities law.
They have limited their involvement in pay issues to trying to restrain bonuses at financial institutions receiving public funds, and even there they have generally moved cautiously and on an ad hoc basis.
But there are signs that governments are going to play a much more active role even after the good times return.
At the government-controlled Royal Bank of Scotland, for example, this new austerity is exemplified by a bonus regime that pays top-earning executives only their base salary — traditionally about 10 to 20 percent of total compensation — in cash. The rest of their yearly awards will come in subordinated debt, as opposed to deferred stock, to be parceled out over a three-year period and subject to a clawback provision if the profits on which the bonuses are based prove to be illusory.
Last year, according to people briefed on the bank’s bonus policy, all the top earners outside of executive directors received their entire 2007 bonuses in cash in the early months of 2008.
The bonuses totaled £2.5 billion, or about $3.65 billion, out of a companywide profit of £7.7 billion, about $11.23 billion — during a year when flawed trades, souring loans and a misconceived merger brought the bank to the brink of failure.
Officials at the British Treasury and the financial authority are keeping a close watch on how the new approach at Royal Bank of Scotland works out, to see if it has any broader applicability.
At any rate, the days of big bonuses are most likely over. As Mr. Turner put it speaking at Cass Business School, criticizing the “illusory bank profits” of the last decade, “It is possible for a system to extract rent beyond its actual contribution.”