No longer can banks carry on regardless

They had become so used to flexing their economic muscle and being listened to by government that they came to believe their own publicity. They thought they were so special, so irreplaceable, so essential to the functioning of the economy that no one would dare to try to run things without them. They seemed genuinely to believe they had a divine right to a disproportionate share of the country's economic output.

It took a long time for them to realise the world had moved on, and the mass of the public had switched off. Their behavioural excesses had destroyed their mystique and provoked a backlash so severe that most of us were no longer interested in them or their ideas — still less their prosperity.

Today's senior bankers have a lot in common with those unions. They too have spent a decade over-exploiting their economic and political muscle, straying well beyond their original purpose, pretending to a mystique and importance they do not possess and trying to extract unjustifiably large rewards for their labours. They too have ultimately been brought down by their arrogance.

And they still don't seem to get it. The excellent City think tank, the Centre for Financial Innovation, organised a seminar yesterday on bankers' pay which sought to explore how it might change — how it might be modified by political pressure and regulation on the one hand, and by lessons learned from the system's near-collapse.

The astonishing thing, though, was how none of the speakers seemed to recognise that the new world might differ from the old. One, indeed, argued passionately in defence of the system, because in his opinion bankers' bonuses played no meaningful part in the events which led to the disaster.

This view is at odds with that of former US Federal Reserve chief Paul Volcker (who has said that remuneration systems removed the incentive to worry about risk), with Lord Turner of the FSA (who has pointed out how the pursuit of bonuses amplified the excesses), and with almost everyone else who has thought about the bonus issue for more than five minutes.

The problem is that bonus schemes motivate employees but too often produce perverse and unforeseen consequences. Thus an employee produces an idea which he thinks is good because he might earn $20 million from it, but he neglects to mention the downside, which is that it could blow up the bank or do serious damage to customers.

If that employee were simply on a salary, he or she would have no incentive to produce such a dangerous notion. But because he or she is on a bonus which will deliver huge personal rewards, while any pain will fall on shareholders or the government — they have a strong reason to be irresponsible.

No other business does this. The motor industry does not encourage workers to produce fuel-efficient cars and then ignore the fact the wheels fall off at 70 mph, nor does the drugs industry encourage miracle cures for a disease and ignore the unfortunate side-effect that the patient grows two heads. Instead they manage their employees to meet corporate objectives instead of washing their hands of management and expecting bonuses to do it for them.

This is not a new problem. Back in 1988, when Rodney Galpin was parachuted in from the Bank of England to rescue Standard Chartered, he found that the root of the problem was that the executives had been incentivised to grow the balance sheet, so they did so by taking undue risk. The same philosophy blew up Barings seven years later. Yet bankers persist in thinking that massive bonuses have a place in banking, while all the evidence is that years of modest benefits are more than wiped out by occasional disasters.

The bonus culture has destroyed banking and led the country to the brink of disaster. Politicians have told the industry they must find another way to run their businesses. If the banks continue to think they can ignore the flak and carry on as before, they risk an evening bigger backlash.