Return of the bonus

The Chancellor wants bankers to 'get real' over bonuses, but are payouts in the City getting out of hand again, or are executives like Stephen Hester just easy targets? Nick Clark reports

Alistair Darling is unhappy. The spectre of City bonuses – a particular government bugbear – is back in the headlines, and the Chancellor fears that the banks are resurrecting the culture that undermined the global economy in the run-up to the crash.

Mr Darling told The Independent this week that some bankers were "complacent", and that those who looked like they were returning to excessive risk-taking would "need to be brought back to earth".

This comes after fury from the trade unions over the size of the incentive package offered to Stephen Hester, the banker charged with turning Royal Bank of Scotland around, as well as talk that some of the Wall Street banks are set to pay out record bonuses this year.

In response to the Chancellor's comments, his Tory counterpart, George Osborne, yesterday said he had warned that "another unacceptable round of big bonuses were on their way. The banks should watch out they don't misuse taxpayer support – it's there to support lending in the economy, not mega-pay deals".

The culture of bonuses has long been a political football, but was named as one of the principal reasons behind the collapse of the world markets. Banks were blamed for incentivising short-term risk-taking, and encouraging tactics that made their institutions inherently unstable.

As bankers became public enemy number one and the Government was forced to step in to bail them out, their remuneration packages came under intense scrutiny. Executives at banks including Barclays, HSBC, and Lloyds as well as most of Wall Street renounced their bonuses for last year.

But now the issue has returned, and is important enough for the Chancellor to take a keen interest.

One investment banking source said yesterday that bonuses were likely to be up this year for two reasons: the firms have seen business rocket, and the hiring merry-go-round has restarted. The source added: "We are only at the halfway stage. If the market collapses, like in the last quarter of 2008, the bonuses will go with it."

Banks are offering bonuses to keep their best staff in place and hire rivals. "They want the best people, and this is how you get them," one banker said. Investment banking activity, rather than retail banks like RBS, has picked up in the first half of the year. While mergers and acquisitions activity has remained weak, the market has been flooded with rights issues and companies looking to restructure debt or raise equity in the market.

Rights issues, such as that completed by the mining giant Rio Tinto this week, generate fees of 2 per cent to 4 per cent for investment banking advisers. This year, companies in Europe have raised $123bn (£75bn) through rights issues, up from $84bn last year, the data provider Dealogic says. At the same time, equity capital market activity totalled $172bn, up from $143bn. Banks' trading floors have also seen solid returns from foreign exchange and commodities trading.

The Government has signalled that it is keen to stamp out the bonus culture, with the Prime Minister last year saying: "The days of the big bonuses are over." Banks have reacted, and many have increased employees' basic salaries to get around the thorny bonus issues. "If you ban bonuses, the way to retain staff is with a higher salary," a banker said, adding: "Raising the base salary is crazy; it's like a guaranteed bonus, even if there's underperformance." In the US, Morgan Stanley doubled the salary of its chief financial officer and co-presidents, while others, including Citi and UBS, have looked at it.

The Government is still steering clear of introducing official bonus caps, but a White Paper published next week is set to hand increased powers to the Bank of England and the UK's Financial Services Authority to prevent excessive risk-taking in the financial markets. Colin Melvin, chief executive of Hermes Equity Ownership Services, a group that represents shareholdings worth £50bn, has called for a "paradigm shift in the way the City works".

He said: "We need to usher in a new culture which rewards the creation of sustainable wealth and shuns short-termism in the relationship between shareholders and the companies they own. Further regulation is only part of the solution."

Mr Darling has said of the bankers: "If they go back to the way they were – to business as usual – without asking themselves over and over again whether they understand what they are doing, that would be disastrous for them and the rest of the world."

Banks are looking at ways to link incentive payments to performance, and now talk about Ltips – long-term incentive plans – rather than bonuses.

One banker said: "Firms are going to look increasingly at Ltips. Staff will be paid more often in shares, to link their performance more closely to the interests of the firms."

The bonus culture has returned to the US, in part after curbs were removed. The banks that participated in the US government's Troubled Asset Relief Programme had to scale back bonuses for their top employees, but many have sought to repay the state and restart incentive payments.

One banker said: "All this talk that 'bonuses are back' is rubbish. They never really went away. Bonuses were lower last year but will be back in 2009, if activity stays like this."

In the thick of it: How the row over bonuses reignited

Bonuses aren't paid out to the banking industry until the end of the year, but the issue reignited this month after Royal Bank of Scotland announced details of Stephen Hester's remuneration package. Mr Hester. left, was dubbed "Stevie Wonga" by the red-top newspapers after it emerged that he would take home almost £10m if he can double the bank's share price within three years.

This came as reports of investment banking bonuses emerged. Goldman Sachs has performed strongly this year and staff can expect record bonuses, according to reports. The group's total remuneration pool – including salaries, bonuses and benefits – is worth about $12bn.

Nomura also said in June it was planning to change its traditional-style contracts for performance-related pay.

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