Leading article: The banks are heading for a crude political backlash

Profits should be used to help struggling firms, not to pay bonuses
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The row over bank bonuses is growing ever more intense. The latest figure to weigh in is the Governor of the Bank of England, Mervyn King, who acidly suggested last night that, following the state rescue of the banking sector, "never in the field of financial endeavour has so much money been owed by so few to so many". Yet the crucial point about excessive remuneration payments is that they are a symptom of the unreformed nature of the financial sector that emerged from the banking crash.

A relatively small number of "too big to fail" financial institutions emerged from that crisis, all effectively guaranteed by taxpayers. They are now posting profits. But these profits all come from trading activities, not from the performance of investments in the real economy. Those profits are up because these banks are riding a wave of renewed confidence in the financial markets. They have also been aided by their access to cheap funds from central banks, which have all slashed their interest rates.

Normally those profits would be eroded by competition from other investment banks. But the disappearance of several big institutions last autumn has reduced that competition, leaving the survivors able to charge hefty fees and take abnormally lucrative positions.

If these banks were making those profits without privileged access to easy money from central banks and without an implicit guarantee from the state that they will be rescued if their bets go wrong, they would be entitled to pay their employees whatever they considered appropriate. Similarly, if they were speculating with the money of wealthy private investors rather than the deposits of ordinary savers they could legitimately tell politicians to mind their own business. If they bear the risk, they should be allowed to take the reward.

But at the moment we, the taxpayer, take the risks, while the employees of this privileged sector are in line for vast bonuses. As the shadow Chancellor, George Osborne, put it in his recent conference speech, this is not a free market, but a free ride. It is not only morally unacceptable, it is economically dangerous.

The G20 proposals for bonus "claw-back" clauses to be written into contracts are directed at the symptoms, not the cause of the problem. The solution is to break up these financial empires, ensuring that high-risk trading operations are not mixed up with the crucial "utility" of retail banking. As Mr King argued last night, the taxpayer support for inherently risky speculation must go.

But the reality is that we are unlikely to get such structural reform any time soon. So the question is how to deal with the immediate problem of outsize taxpayer-underwritten bonuses? A windfall tax has been mooted. This is hardly desirable. Such special taxes tend to be economically distorting. It would be far better if the banks were not to make these payments in the first place. They should use their profits to lend to small and medium-sized businesses which are still being starved by retailing banks of the working capital they need. At the very least the banks should use these funds to replenish their own capital which, in many cases, remains below safe levels.

Yet the managements of several of these institutions seem determined to continue as if last autumn's near cataclysm never happened; as if the entire financial sector had not been bailed out by taxpayers. If they insist on ploughing ahead and awarding these bonuses, the banks will feel a crude political backlash. And they will only have themselves to blame.

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