In December 2022, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) issued a joint consultation setting out their intention to remove the requirements on banks governing the ratio between fixed and variable components of total remuneration, commonly known as the “bankers’ bonus cap”.
Triodos Bank UK agrees that the bonus cap has not been as effective on delivering its ambition as it could have been but does not support its complete removal.
Instead, Triodos would encourage the PRA and the FCA to consider how identified weaknesses in the bonus cap could be addressed, and its original objectives be delivered, as part of a package of measures that incentivise a banking system that creates societal value. Such a package would focus on controlling total remuneration and include removing the ability for banks to use Role Based Allowances (“RBAs”) as a means of circumventing the bonus cap. Triodos also proposes increasing disclosure requirements for the highest earning Material Risk Takers (“MRTs”) and introducing limits or targets on the ratio of the highest earners to median earners within an organisation. Triodos believes that collectively these steps would support a transition to values-based banking that better supports the real economy and better serves society as a whole.
Triodos’ approach to remuneration
Triodos, as an international banking group, is built on three founding principles:
- To help create a society that promotes people's quality of life and that has human dignity at its core
- To enable individuals, institutions, and businesses to use money more consciously in ways that benefit people and the environment, and promote sustainable development
- To offer customers sustainable financial products and high-quality service
In line with this, Triodos applies a remuneration policy that it believes enables co-workers to earn a decent living and to contribute to the organisation and society at large whilst maintaining a relatively low ratio between the lower and higher levels of salary paid. This is in line with Global Reporting Initiative (“GRI”) standards for sustainability. Variable components are very limited, modest, and discretionary in nature, and in 2022 the ratio of highest to median salary across the group was 5.1. This is done in the belief that all co-workers are jointly responsible for sustainably realising the mission of the bank.
Triodos has consistently achieved positive financial performance and growth under this remuneration structure, providing an example to the wider industry that such an approach is possible.
Whilst the bank recognises that variable compensation forms a key component of remuneration for many other institutions, it believes the principles that sit behind its approach can, and should, be adopted more widely. Excessive remuneration is damaging to the reputation of the banking industry, does not reflect fair value for the real economy, and creates greater inequality within wider society. Removing the cap on banking bonuses will inevitably contribute to damaging and excessive levels of remuneration, as seen in previous banking booms.
Assessment of the impact of the bonus cap
As highlighted in the PRA and FCA’s consultation paper, the introduction of the bonus cap has resulted in a consistent decrease in the ratio between average bonus and total remuneration. The paper notes that increases in fixed pay were in part driven by increases in RBAs and raises concerns that the decreased portion of variable compensation (a) inhibits banks’ ability to absorb losses in a downturn, and (b) inhibits the ability to incentivise performance and risk management. On each of these points:
- Triodos agrees that the use of RBAs has materially limited the positive impact of the bonus cap. However, instead of removing the cap entirely, Triodos would advocate for tightening the rules around the cap to prevent its abuse through RBAs and allow the cap to deliver on its originally intended objective of reducing excessive risk taking
- Reducing bonuses to absorb losses in a downturn is a reactive measure that speaks to a lack of sustainability in the approach the industry takes to compensation. Triodos believes that it would be more beneficial to incentivise long term sustainability in the banking industry. Triodos believes that a greater use of fixed remuneration, in parallel with removing loopholes such as RBAs, would incentivise banks to become more commercially sustainable, reduce the risks they individually take, and reduce the long-term level of risk within the financial system
- Triodos recognises the PRA and FCA’s concern that the bonus cap inhibits the ability to incentivise performance. However, under the current regime bonuses make up 40% of total MRT remuneration and still provide a significant incentive to recipients. This status quo provides ample scope to incentivise risk-aware performance, a critical part of overall performance
The consultation paper does not go into detail on how the introduction of the bonus cap has impacted total compensation within the banking industry, and the banking industry’s corresponding contribution to inequality in society. Given the need for sustainable and real economic value-based remuneration, this feels like an omission. If the bonus cap has reduced the level of total compensation, it would have been at least partially successful in reducing the level of undue risk taking within the industry. Triodos would encourage the PRA and the FCA to consider performing more detailed analysis on the impact of the bonus cap on total remuneration as part of any decision taken on the back of this consultation paper.
The downside impact of removing the bonus cap
Triodos is concerned with the impact that completely removing the bonus cap could have. These concerns focus on two areas: (1) public perception and confidence in the banking system, and (2) the potential negative impact on equity, diversity, and inclusion.
Public perception and confidence in the banking system
The UK has been going through a period of significant economic stress over the past five years. This has culminated in the cost-of-living crisis that emerged in 2022 and continues into 2023. Household budgets are stretched, and families are having to tighten strings to meet their essential needs, such as for housing (for both renters and mortgage holders), energy, and childcare.
Alongside this, the banking industry continues to struggle with a reputation of poor management and excessive risk taking that has pervaded since the global financial crisis of 2008. This has been brought into recent attention with the market volatility in March 2023, and the failures of Silicon Valley Bank (“SVB”) and Credit Suisse.
Given both factors, it would be reputationally damaging for the PRA and FCA to be seen to be relaxing rules on bankers’ bonuses at this time. It would increase distrust of the industry in the eye of the public and be interpreted as a return to the excessive risk taking of the early 2000s. This would in turn damage confidence in the UK financial services industry as a whole and impede on the PRA’s primary safety and soundness objective. Triodos believes that the financial system is significantly better placed to withstand a crisis than during 2008 but, as recent examples have shown, public perception and confidence are critical elements to a sustainable and well-functioning banking industry.
Equity, diversity, and inclusion
The PRA acknowledges in its consultation paper that its proposed measures may indirectly increase “equality, diversity, and inclusion issues”, as evidenced by research showing higher gender bonus pay gaps compared to fixed pay gaps.
Financial services already suffer from some of the largest gender pay gaps in our society. Research from the Equality Trust highlights this issue and provides evidence that variable compensation exacerbates the challenge. Their report “Gender pay gap data analysis, November 2020” highlights that average bonus pay gaps across the economy increased from 10.0% to 27.9% between 2017 and 2020. In a specific example, the report highlights that in 2019, HSBC reported an overall gender pay gap of 55.1% but a bonus pay gap of 68.5%.
The PRA highlighted in its statement of its 2023 priorities for UK deposit takers that it expects firms to continue to embed diversity, equity, and inclusion (‘DEI’) within their cultures and has highlighted that the industry should expect a new regulatory framework on DEI to be consulted on during 2023. The joint FCA and PRA 2021 discussion paper highlighted the importance of DEI in strengthening the resilience of the financial services industry as a whole. Proposing a measure that will, directly or indirectly, hinder this for limited benefit would appear to run counter to these objectives. Triodos urges the PRA and FCA to follow up on their commitment within paragraph 2.55 of the consultation paper and to rigorously review the potential negative impact on DEI the proposed measures will have.
As outlined above, Triodos does not support the complete removal of the bonus cap. Instead, Triodos would encourage the PRA and the FCA to consider how identified weaknesses in the bonus cap could be addressed, and its original objectives be delivered, as part of a package of measures that control total remuneration and incentivise a banking system that creates societal value. Any bonus awards at a senior level should be geared to holistic aims, such as the. achievement of carbon reduction targets or social KPIs, alongside financial performance.
Triodos would recommend the PRA and FCA consider the following next steps:
- To review the moral hazard of removing the banking bonus cap following the recent turmoil experienced by the banking industry during March 2023
- To deliver on their commitment to rigorously review the potential negative impact on DEI the removal of the bonus cap would have
- To analyse the impact the bonus cap has had on total remuneration within the banking industry
- To update the mechanism for calculating the bonus cap to remove the potential for its abuse through RBAs
- To enhance visibility of excessive remuneration within the banking system by:
- Setting limits or targets for the ratio of the highest earners to median earners within an organisation
- Requiring enhanced disclosure of individual MRTs earning over defined thresholds, in line with existing requirements for company directors
- Introduce a wider range of pay gap reporting (e.g., by ethnicity) to complement existing gender pay gap reporting
Triodos believes that collectively these steps would support a transition to values-based banking that better supports the real economy and serves society as a whole. This in turn would contribute to a safer, more robust and fairer banking system, in line with the PRA and FCA’s wider objectives.