Remuneration in the City of London
The report concludes that the banking crisis has exposed serious flaws and shortcomings in remuneration practices in the banking sector and, in particular, within investment banking. Moreover, the Committee is concerned that the FSA’s Turner Review downplays the role that remuneration played in causing the banking crisis and questions whether the regulator is attaching sufficient priority to tackling the issue.
Committee Chairman John McFall said:
"Bonus-driven remuneration structures led to a lethal combination of reckless and excessive risk–taking. The design of bonus schemes was not aligned with the interests of shareholders and the long–term sustainability of the banks and has proved to be fundamentally flawed. Our report outlines clear failings in the remuneration committees within the banking sector, with non–executive directors all too willing to sanction the ratcheting up of senior managers’ pay, whilst setting relatively undemanding performance targets. Looking forward, we are also concerned that the FSA seems not be taking tackling this issue seriously enough."
Bankers’ apologies and Sir Fred Goodwin’s pension
The report notes that the apologies the Committee heard from former RBS and HBOS executives had a polished and practised air. These witnesses also betrayed a degree of self-pity, portraying themselves as the unlucky victims of external circumstances, it says. Discriminating between the personal blame that should attach to bank executives, and that appertaining to the force of global circumstances is difficult. However, it is self-evident that some banks have weathered the storm better than others; and some have not required taxpayer assistance to navigate through the ‘credit crunch,’ the report concludes.
John McFall said:
"Our previous report on the banking crisis did not name individuals. However, it was never our intention to shy away from this. Prior to their public fall from grace, the former bankers from whom we extracted apologies were regarded as among the most able and competent leaders in British industry. This makes the charge of management failure impossible to resist. The banks that have failed did so because those leading and managing them failed. Much criticism has also been rightly levelled at the culture in the City of London, which encouraged excessive risk taking. Our previous report acknowledged the failure of governments, politicians, regulators and central bankers to check this culture, but banks’ boards must also take a large share of the blame."
The report concludes that Lord Myners’ assertion that his precept to the RBS Board - that there should be no reward for failure - did not represent an adequate oversight of the remuneration of outgoing senior bank staff. Instead, it would have been far better if Lord Myners had given a stronger, clearer direction of Government requirements for a bank in receipt of public funds and had assured himself by demanding to be kept informed of the detailed negotiations that were taking place. The Committee is further not convinced that Lord Myners was right to take on trust RBS’s suggestion that there was no option but to treat Sir Fred as leaving at the employer’s request. It would, in the Committee’s view, have been open to Lord Myners to insist that Sir Fred should have been dismissed. Finally, the report casts doubt on the Treasury’s decision to rely on the then RBS Board to handle these negotiations without direct Treasury involvement. The RBS Board had shown itself to be incompetent in the management of the bank, steering it towards catastrophe, and was also possibly dominated by Sir Fred; there were no grounds for trusting them with this operation, the report says.
The financial crisis has exposed serious flaws and shortcomings in the system of non–executive oversight of bank executives, the report says. It pinpoints three problems: the lack of time many non–executives commit to their role, with many combining a senior full-time position with multiple non–executive directorships; in many instances a lack of expertise; and a lack of diversity. It calls for a broadening of the talent pool from which the banks draw upon, possible restrictions on the number of directorships an individual can hold, dedicated support or a secretariat to help non–executives carry out their responsibilities effectively, reforms to ensure greater banking expertise amongst non–executives directors, as well as stronger links between non–executive directors and institutional shareholders.
John McFall said:
"We were shocked when we discovered many non-executive directors were holding not only senior full-time jobs but also multiple non-executive directorships, as well as other roles. This simply cannot have given them the time to conduct proper oversight. Too often seemingly eminent and highly–regarded individuals failed to act as an effective check on, and challenge to, executive managers, instead operating as members of a ‘cosy club.’ Such incestuous and frankly ineffective behaviour must come to an end."
Remuneration in Lloyds and RBS
On the issue of remuneration practices in the part–nationalised banks, the report acknowledges that, whilst there is a strong case for curbing or stopping bonus payments for senior staff in Lloyds Banking Group and Royal Bank of Scotland, the position of the banks would be worsened if they could not make bonus payments. That said, the report highlights a lack of transparency regarding the exact cost of bonus payments and these banks, including deferred bonus payments, and calls on the Government and UKFI to rectify this.
The report also proposes a number of reforms to remuneration more widely in the banking sector. These include enhanced disclosure requirements on firms about their remuneration structures and about remuneration below board–level, reforms to remuneration committees to make them more open and transparent, and a Code of Ethics for remuneration consultants.
John McFall said:
"If bonuses were prohibited at the part-nationalised banks, they could struggle to retain and recruit the staff they need, to the detriment of the taxpayer as a major shareholder in both institutions. However, as a major shareholder, the taxpayer is also entitled to transparency and accountability regarding pay structures and how they relate to performance. Rewards for failure must not be repeated. This applies not just to Lloyds and RBS, but across the board."
The report notes the failure of institutional investors effectively to scrutinise and monitor the decision of boards and executive management in the banking sector, concluding that this may reflect the low priority some institutional investors have accorded to governance issues, and that, in some cases, they may have even encouraged the risk-taking that proved the downfall of some banks. The Committee is particularly concerned that fragmented and dispersed ownership, combined with the costs of detailed engagement with firms by shareholders, resulted in the phenomenon of ‘ownerless corporations.’
John McFall said:
"The failure of institutional investors has been another sobering lesson to emerge from the banking crisis. Their engagement with the banks prior to the crisis was often too weak or non-existent, allowing bank executives to operate in a vacuum. Policymakers need to focus on how we can promote more effective shareholder engagement. There is a degree to which seemingly ownerless corporations were allowed to operate outside the bounds of accountability; this must end."
The audit process failed to highlight developing problems in the banking sector, leading the Committee to question how useful audit as it is currently designed is. The report also questions the issue of auditor independence and argues that investor confidence and trust in audit would be enhanced by a prohibition on audit firms conducting non–audit work for the same company. The FSA should also consult on ways in which financial reporting can be improved to provide information on bank activities in a more accessible way, it says.
John McFall said:
"Our report does not conclude that auditors failed in their duties. However, the banking crisis has raised some serious questions about the usefulness of financial audit, and we have put forward suggestions for change. For example, financial statements are impenetrable to most people; instead they should be telling a story of what the firm has done in the past year and give a clearer idea about where future risks may lie."
“Our inquiry into the causes of the banking crisis has been an epic undertaking. We have held 17 evidence sessions and heard from over 100 witnesses. Today’s report also looks at credit rating agencies, accounting standards and the role of the media in the crisis. This is not the end of the story, we will turn the spotlight onto the FSA in coming months, looking at the future regulatory landscape and making sure the right lessons have been learned. We will also be doing further inquiries looking at how to rebuild consumer trust in the financial sector as well as the international aspects of the banking crisis."
Previous banking crisis reports