Pay at investment banks is starting to fall, but not because politicians have
capped it
Jan 4th 2014
NAUGHTY or nice is not a discussion investment bankers have with Santa before
Christmas but one they have with their bosses early in the new year. The
haggling usually opens with the boss saying what a tough year it has been and
the bankers, often experienced traders and dealmakers, talking about how
valuable they are. This year s negotiations will be unusually tense. At stake
will not simply be pay, an issue complicated by the introduction on January 1st
of a bonus cap in Europe, but also jobs.
After peaking at the end of 2010, employment in the investment-banking industry
has been declining steadily. Deutsche Bank reckons that the number of bankers
employed by the ten largest firms will fall by about 3,000 in 2014, leaving the
total 20% below its peak. Add in job losses at smaller firms and declines in
support staff, and total worldwide employment in the industry may fall by
20,000 this year.
Pay is dropping too. At Goldman Sachs and JPMorgan Chase average pay slipped by
about 5% in the first nine months of last year, a figure that is probably
representative of the wider industry. Over the longer run, average pay at the
world s biggest investment banks has barely changed (see chart), which means it
has fallen slightly after inflation. The pace of pay cuts is likely to
accelerate, senior bankers say.
The biggest reason for the cutbacks is that after decades of growth in revenues
(punctuated by brief declines), the investment-banking industry is facing a
structural downturn. Regulators in America have banned banks from trading
securities for their own profit. Higher capital standards everywhere are
forcing investment banks to shrink their balance-sheets and regulations are
making banks move much of their derivatives trading from opaque and profitable
over-the-counter transactions onto exchanges and into central
clearing-houses, where fees are likely to fall.
Although final figures are not available, the investment-banking revenues of
the industry s biggest firms probably fell by about 5% in 2013, according to
Coalition, a data-provider. That leaves them about a quarter lower than their
peak in 2009.
In fact, the industry s revenues and profitability have fallen far more sharply
than pay and employment. McKinsey, a consultant, reckons that for the 13
biggest investment banks revenues have fallen by 10% a year since 2009, while
costs have dropped by just 1% a year. The main reason for this mismatch is the
relentless optimism of those who work in the industry. Most big banks hired
energetically after the financial crisis, hoping to gain a greater share of the
market as rivals cut back.
Another reason is the difficulty in making incremental cuts at investment banks
without shutting down whole departments. Trading businesses often have large
fixed costs such as computer systems and compliance departments that are
difficult to shrink. Simply thinning the numbers of traders and bankers often
results in revenues falling faster than costs.
A failure to cut costs fast enough means that the industry s profitability has
been ruined. Average returns on equity for the biggest investment banks slumped
to about 8% last year, according to McKinsey. Without deep cost cuts it reckons
this figure will fall to 4% by 2019. That sobering prospect is now prompting
deeper cutbacks, particularly at European banks such as UBS, Credit Suisse and
Royal Bank of Scotland which are getting out of whole lines of business. UBS,
for instance, has decided to get out of most debt trading and is trimming about
10,000 jobs.
Against this backdrop there is one part of bankers pay that is likely to rise.
New rules that came into force at the start of the year in Europe will prevent
banks from paying thousands of key employees bonuses that are bigger than their
annual salaries. The result will not be the cut in total pay that European
lawmakers expected. Instead banks have already figured out wheezes to work
around the rules.
The first is to bump up basic salaries while reducing the portion of pay
allocated to a bonus. This cuts against much of the work done by regulators to
tie bankers pay to performance and to defer large chunks of it so it can be
withdrawn if the bank subsequently does badly. In Britain, for instance, the
country s highest-paid bankers received bonuses in 2012 that were 3.8 times
their salaries.
Across the industry most big banks have signed up to international principles
under which 60% of bankers total pay should be deferred (and thus not part of
basic pay), according to Oliver Wyman, another consulting firm. That trend is
likely to reverse in Europe, bankers say. The more I pay in fixed, the less I
have to claw back, complains the boss of the European arm of a large
international bank. This doesn t do what the legislation wanted it to do.
A second wheeze being tried by international banks is to exploit a loophole
that allows them to pay bonuses that are twice as large as normally allowed if
shareholders approve this in a vote. Since many are structured as subsidiaries
whose only shareholder is their parent bank, getting shareholder consent is a
doddle.
Other ploys include paying monthly cash allowances or granting forgivable
loans that only have to be repaid if the banker leaves within a certain period
of time. The impact of these ruses will, however, be limited, mainly because of
relentless pressure on banks to cut pay to improve returns for shareholders.
After years of watching their employees naughtily pocket large cheques while
passing losses on to shareholders and taxpayers, the owners of banks are in no
mood to be nice.
From the print edition: Finance and economics