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The financial industry around the world must refrain from concluding absurd bonus agreements in the competition for the best talents... Among other things, a bonus limit of one to two times the fixed salary is being discussed at European level. This limits the compensation to a certain degree. However, banks can adjust their fixed salaries to get the results they want.
Does that mean legislators are powerless?
No. There are a number of useful regulations. I believe that banks should defer an even larger proportion of the bonus claims over a longer period. The current agreements specify a deferral period of three to five years. Personally, I would prefer five years, or even longer for large bonuses, because some banking business only proves to be risky after a few years. However, these kind of compensation rules would then need to be coordinated and agreed upon internationally.
Should bonuses be linked to an institution’s total profit, and should they be withheld if a loss is made?
Yes, the proposals from the Liikanen Group embrace a similar concept. Banks should pay out a proportion of their employees’ bonus claims in the form of debt securities, known as “bail-in” capital. Should the institution get into trouble, these debt securities are converted into equity and thus participate in the bank's loss. However, compensation regulations like this would need to be coordinated and agreed internationally.
What are the lessons to be learned from the Libor affair? Elke König, the head of Germany’s Federal Financial Supervisory Authority (BaFin), has called for the Libor to be scrapped.
My chief concern is that the markets have informative interest rates and that orderly processes are used to set the reference interest rates. Of course, the latter does not solve the problem that the Libor and Euribor rates contain conceptual flaws. However, I have my doubts as to whether we can simply do away with these rates. That is easier said than done because reference interest rates are not only a benchmark for institutional investors, but also for private house builders. We therefore need a sensible solution that has been coordinated and can be agreed upon at an international level. The relevant bodies are developing potential solutions. We should wait for their proposals.
Nevertheless, what fundamental changes need to be made to the way the reference rate is calculated?
Institutions need to comply with documentation requirements and control structures when submitting data and assign the provision of information for Libor and Euribor interest rates to a higher risk category. Submitting interest rates was often classified as a low risk activity. The control systems in place at the institutions were therefore underdeveloped. We need to put a stop to this to prevent this type of scandal from happening again...
This kind of cultural change would have to come from the top, wouldn’t it?
Absolutely. The change must be led by members of the executive board. But the banks’ shareholders also need to show a renewed interest in sustainability. Shareholders or investors who demand double-digit returns should not be surprised if banks start to take extra risks.
There are plans to concentrate banking supervision at the ECB so that such risks can be identified at an early stage in future. Can an authority this large function effectively?
Yes, if it is carefully prepared and if there is optimum cooperation between national supervisors and the ECB. It is worth making the effort, because a European supervisory authority could be of considerable benefit. First, it is important that the national central banks are able to contribute their macro- and micro-economic knowledge to this system, because they are the ones that have an overview of not only their local banking business, but also regional economic developments and the national infrastructure. Second, it is not enough to assess only institution-specific figures. Instead, they need to be used to make a useful cross-border comparison. Third, regular contact with those in senior roles at the banks is required. Supervisors need to understand the culture and the jurisdiction. Fourth, this European supervisory system requires a single supervisory approach, which sounds simple but is difficult to implement.
What are you focusing on?
The focus of the German supervisors is currently on the institutions’ business models. Which transactions does the institution hope to use to generate profit? Is that possible in light of the specific national or regional economic situation? What is the competitive environment in which the bank operates? If 2,000 institutions in Germany wish to expand their business with small and medium-sized enterprises (SMEs), the issue of margin pressure soon arises.
Is the plan to introduce European banking supervision in March 2014 actually realistic?
The schedule is very ambitious. However, it is basically feasible – but only if we build on the existing structure. If everything has to be set up from scratch, it is not achievable organisationally, conceptually or in terms of staff.
How many staff does the ECB need for banking supervision?
It is difficult to say, but it needs enough to cover three aspects: first, the ECB banking supervisors responsible for supervising institutions must be able to talk to national supervisors on an equal footing. Second, they need a work unit in charge of creating comparisons, whose main responsibility is making sensible use of the information gathered. Third, they need staff who work on regulatory issues.
The central bank governors in each country have the last word on banking supervision. Is that compatible with the principle of independent monetary policy?
Strict separation between monetary policy and banking supervision is desirable.The decision to set up supervision at the ECB was made so that responsibility now lies with the ECB’s Governing Council and its members.We must now fulfil this responsibility...