After years of cosying up to the City of London, the Labour Government is clamping down on pay in the banking sector. The Treasury said explicitly yesterday that the authorities would look at banks' pay when deciding whether to support banks with capital injections.
Financial authorities in the US and the UK believe the high pay and bonus culture at banks contributed to the sector's reckless practices by offering massive rewards for short-term profit. Bonuses in the millions for chief executives and traders alike helped turn the stolid industry of banking into a casino of proprietary trading, overstretched balance sheets and warehousing of dodgy securities.
Those practices created massive profits for banks in the boom years but many have now lost all the gains and the wider economy is paying the price. Yet though their companies may have gone to the wall or come close to oblivion, individual bankers have kept the bonuses that rewarded their excess.
Sir Fred Goodwin, the chief executive of Royal Bank of Scotland, earned £4.1m last year, including a bonus for the bank's acquisition of ABN Amro, which the bank now admits it overpaid for. Andy Hornby, the boss of HBOS, earned £1.9m in 2007 but his bank was forced to sell itself to Lloyds TSB last month to avoid going bust.
Lloyds own chief executive, Eric Daniels, was paid £2.4m last year.
The Prime Minister said yesterday that the Financial Services Authority would draw up a code covering executive pay at the banks. The move will formalise measures announced earlier this year when the FSA said it would include pay schemes when assessing the riskiness of a bank's business model.
Watchdogs already exercise control over pay in regulated industries such as the energy sector, Stella Brooks, director at Inbucon, the pay consultant, says. It is easier for those regulators because they control pricing and companies know that excessive pay can be punished with lower prices.
Banks are also more complicated because their chief executive's pay is often vastly outstripped by earnings of top traders or merger advisers. The most high-profile disclosed bonus in the City is that of Bob Diamond, the president and investment banking chief at Barclays. Mr Diamond earned £250,000 in salary last year but was paid a £6.5m cash bonus, with share options taking his total remuneration to £18.5m.
Peter Hahn, a fellow at Cass Business School, argues that changing banks' pay structure to ward against short-term excess is simple. Simply align chief executives' pay more closely to risk and they will do the rest of the work to make sure they get a bonus at the end of the year.
The banks have insisted for years that they operate in international markets and that their chief executives are in constant danger of being poached by US banks for far higher rewards. But that argument is harder to make with banks in the US reporting massive losses and a big backlash against excessive pay and pay-offs for chief executives.
"If banks try to use that argument now, that is when the regulator turns round and says, 'Fine'," Ms Brooks says.
Critics of the Government have said that its claim to be clamping down on City pay is political posturing that will be conveniently forgotten because the country relies on financial services' pay to drive the economy and provide tax revenue. The Centre for Economic and Business Research has forecast that City-type bonuses will fall to £5bn this year, from £8.5bn in 2007. That spells bad news for the UK's finances, which CEBR calculates could have received about £3bn from last year's bonus pool.