Thursday, 4 December 2008

Controlling the earnings of bankers

There was nothing really original in the comments last night by the former Reserve Bank Governor Ian MacFarlane that a complex system of perverse incentives that had rewarded those who chased high returns and chose to "ignore or downplay the risks" was at the heart of the world's current financial turmoil. The Australian Prudential Regulatory Authority was making similar comments last year before the crisis was a crisis. The men at APRA, like McMacFarlane, drew attention to the danger that multi-million dollar bonuses encouraged risk taking. The regulator gave a warning to the boards of financial institutions to look carefully at the incentives it offered executives but what it did not do was suggest to the then Coalition Government that they should be allowed to take actions if their words were ignored.
Perhaps this blunt judgment looking backwards by Mr MacFarlane will give the Labor Treasurer Wayne Swan the courage to act that his predecessor Peter Costello lacked:
"The biggest misdirected incentive was the performance-based pay structures which awarded massive bonuses to the management of financial institutions on the basis of short-term profit results. Annual bonuses in the millions or tens of millions of dollars were available to the most successful profit earners, and, of course, were not returnable when the short-term profits were lost in subsequent years."
Labor should first of all take up the suggestion by the Leader of the Opposition Malcolm Turnbull that would allow shareholders to pass binding resolutions on executive pay. In the case of institutions supervised by APRA, shareholders should be encouraged to use this power by backing it up with regulations allowing the regulator to insist on higher capital requirements when payments are considered to be risky. The conseqauent decline in an institution's profitability would concentrate the minds of shareholders wonderfully.
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