Bankers' pay needs to be curbed further to reflect the risk of a bank failure many years after a bonus has been awarded, the Bank of England (BoE) said before the annual bonus season begins next month.
The European Union has already introduced curbs on bankers' bonuses after huge payouts were criticized for helping to create the climate that led to the financial crisis in 2008. Bank shareholders, too, expressed dismay at large bonuses for bank employees despite poor returns.
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Measures taken so far include the requirement for a portion of bonuses to be paid in shares over several years, but the BoE's Financial Policy Committee (FPC) believes that these do not go far enough.
Chunks of a bonus are typically deferred for only three years. The FPC, which takes over British bank regulation next year, said that this is not sufficient to deter bankers from taking risky decisions that can have an adverse impact many years later.
"Steps could be taken to ensure that contracts provided sufficient incentives for executives to consider the full implications for long-term business performance," the FPC said in the record of its last quarterly meeting on November 21, which was released on Tuesday.
FPC member Andy Haldane, the BoE's director for financial stability, said on Monday that he was seeing encouraging signs of falling pay for bankers and hoped that it would eventually return to a level closer to that of doctors or lawyers.
The FPC said that a good way to make bankers think twice about taking risks would be to require bonuses to include debt that converted to equity in the event of a bank failure.
The idea of including so-called "bail in" debt in banker's pay packages was aired recently in a report by the European Union's Liikanen Group into the future of bank structures. Such a measure could also make it less likely that further taxpayer bailouts would be needed if a bank gets into trouble.
Last week the BoE said British banks needed to act now to bolster their defenses against financial shocks because many had underestimated the cost of loans going sour and future fines for misconduct.
The record of the November FPC meeting that came to this decision showed a clearer consensus on the issue than previously.
Earlier meetings gave what bankers say were a mixed message: that buffers could be trimmed to boost lending to the economy, and that buffers should also be strengthened to make banks more resilient in the face of a rocky economy in Europe.
The latest meeting gave several specific reasons to justify higher bank capital buffers "for the foreseeable future".
The FPC has also told bank supervisors to report each quarter from next March on what Britain's top banks, such as HSBC , Lloyds , Barclays and RBS , are doing to buttress their capital buffers.
Bankers said that the BoE's estimates of a big capital gap appeared to be a warning shot to the industry to keep trying to sell assets and retain capital, for example by paying lower bonuses.
Any capital shortfall was nowhere near as big as the BoE warned, they said, and if it was it would be virtually impossible for some banks to raise what was needed without getting it from the taxpayer.
A British Bankers' Association spokesman told Reuters that UK banks are already well capitalized and positioned for next year's tougher new capital rules, known as Basel III.
(Additional reporting by Steve Slater; Editing by David Goodman)