A pay-up and shut-up deal for the banks

By Philip Stephens

Published: January 31 2011 19:50 | Last updated: January 31 2011 19:50

It is time to make Britain’s banks an offer they cannot refuse.
Politicians, regulators and the media promise to shut up about seven-figure bonuses and opulent lifestyles; in return the banks agree to reimburse taxpayers for the subsidy they receive from the public purse.

Management consultant types would call this a win-win, and economists a market-based solution. The banks stand on their own financial feet; and critics disavow a public interest in their pay packets. The bankers join the ranks of footballers, rock stars and hedge fund
chiefs: the only losers from telephone-number bonuses are soft-headed shareholders and investors.

We know the banks want to quell the controversy. Bob Diamond, the US investment banker who has just taken over as chief executive of Barclays, has put himself in the vanguard of the “let’s draw a line”
brigade. Mr Diamond told MPs the other day it was time to take off the hair-shirt of remorse. As for bonuses, if banks were to compete globally they had to pay the market rate.

Amid the clinking of champagne flutes in Davos, Mr Diamond was joined by colleagues from Europe and the US in offering profuse thanks to governments and regulators for rescuing the banks from their own folly. The purpose of these mea culpas was painfully transparent: to move on.

The snag is that bankers are a million miles from winning the argument in the public square. Mr Diamond may think he has done his penance.
But such acts of contrition as there might have been have escaped the notice of just about everyone else.

As to gratitude for the government bail-outs, the formidable Christine Lagarde has it right. The best way for the banks to say “thank you”, the French finance minister observed, would be to contribute properly to economic recovery, to curb bonuses and to bolster their own capital. Even among the well-heeled Davos audience, Ms Lagarde drew applause.

Public hostility is not about to subside any time soon. As Mr Diamond arrived at the slopes, back in London Mervyn King was spelling out some dismal economic truths. Britain’s households, the governor of the Bank of England warned, face the most sustained fall in living standards since the 1920s.

Yes, the 1920s. The victims of the financial crash are being squeezed by higher inflation, rising taxes and pay freezes. That’s before government spending cuts take their toll on public services. It’s not Tunisia or Egypt; nor even Greece or Ireland. But it’s not fun either.
Mr Diamond is deluded if he thinks he will win credit by paying out million-pound bonuses in bonds rather than cash.

The bankers sense, though, that David Cameron’s government has grown weary of the dispute. Ministerial resolve has weakened noticeably.
Ministers have been unnerved by threats of an exodus from the City to New York, Switzerland or Singapore.

Whitehall officials report that George Osborne, the chancellor, wants to strike a bargain that would provide cover for an official climb-down. The banks would promise to increase their lending to small and medium-sized businesses and to lop a token amount from this year’s bonuses; the government would tone down the political rhetoric.

The trouble is that this is a rotten deal for taxpayers – a point some of the Liberal Democrats in Mr Cameron’s coalition seem to have grasped. It is all but impossible to fix sensible lending targets in advance; and even harder to hold the banks to any promises they may make.

The bigger objection, though, is that such an arrangement takes no account of the massive subsidy provided to the banks by all those angry taxpayers. Even putting aside the special measures offered during the crash, the implicit payout runs to tens of billions of pounds a year.

The subsidy arises from the government guarantees that keep the banks in business – and this includes Barclays as well as the publicly owned NatWest or Lloyds TSB. The guarantees allow them to borrow more cheaply than would otherwise be possible. The consequent profits help pay for the bonuses.

By the Bank of England’s estimates, the value of the implicit subsidy now stands at a staggering £100bn a year. To put that in perspective, the banks’ annual tax bill runs to about £20bn.

To be fair, the subsidy has reached exceptional levels in the past couple of years, reflecting risk aversion in the aftermath of the crash. A return to more normal times should see the subsidy decline, though almost certainly not to as low as the pre-crash £10bn. But the more the banks build their own capital resilience, the lower the figure will go. That is what I call a perfect incentive for the banks to do the right thing.

However justified the public rage, the bankers are right in saying that the government’s approach cannot forever be ruled by emotion.
What is needed is a bargain that sees taxpayers reimbursed and the banks free to run their businesses. So there you have it, Mr Diamond:
you pay up and the rest of us will shut up.

philip.stephens@ft.com

Copyright The Financial Times Limited 2011

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