eFinancialCareers

In the latest installment of his regular “View from the Top” series, our columnist casts a realistic eye over the murky world of banking bonuses. The author is a senior banker based in Singapore, with three decades in commercial and investment banking at major international firms.

I believe that there has been too much anger, emotion and frustration expressed over the large (and seemingly unjustifiable) bonus payments made to senior executives of failed banks. I am not defending these bonuses, but the public should know that such payments have simply been standard industry practice for at least 10 to 15 years.

Bonuses ballooned because excessive risk taking at many global financial institutions generated large annual profits, and also because of inflated US stock values. The top US investment banks and brokerages started this practice and it spread to Europe and Asia, to some extent.

The sins of a few

However, these large bonuses are usually limited to a very select group of employees in a few global financial firms. In my whole career at several top global banks (some of which are now majority government owned), I have never received anything close to the sums reported as paid by AIG or Merrill Lynch. This is despite having contributed to many investment banking transactions where my employers have earned millions in fees and other earnings.

My belief is that some of what has been reported in the press has been sensationalised and extrapolated based on abuses by a few financial institutions. Right now in my current position, I have the benefit of looking across my organisation. I am fully informed of the kind of bonuses being paid out and who is receiving them.

So I can categorically state that, as a general rule, banks do have sufficient checks and balances, and they do have enough rationale-minded managers making decisions about staff pay and benefits. Of course there are exceptions, and abuses do happen from time to time.

In many banks, million dollar bonuses are paid only to a few key professionals in financial market sales and structuring, and also in proprietary trading. In addition, very senior investment bankers/deal-makers and CEOs of large major profit centres do get paid extremely well. It is a general practice that annual base salaries are capped at a certain level (usually about US$250k – US$300k per annum) and real pay comes from bonuses predicated on performance as measured at year-end.

There is, however, also a recent practice of giving contractual future-guaranteed bonuses to new super hires and awarding so called guaranteed retention bonuses to key employees at risk of moving. Many of the reported AIG bonuses are of this type, which are paid regardless of actual performance.

In some ways, the distribution methodology of bonuses is largely to blame for the imbalances between staff in the same company. Total bonuses, available to be paid to all employees, are carved out as a pool of monies based on a percentage of total annual wages of a firm. This total bonus pool can be increased or cut depending on the bank's actual annual performance.

It's who you know

However, larger shares of these pools are usually awarded to departments or divisions based on how strong and influential their managers are within the organisation. They aren't based on the headcount and wage bill of the department. And larger shares are given to divisions which use less bank capital and have less perceived risk in their activities (some of these risk have been terribly understated as we found out later during the financial crisis).

The distribution method hence benefits small profitable departments who handle very large complex off-balance-sheet structures and rely on only a few highly skilled, intelligent and innovative employees. And it penalises departments who need large numbers of staff, such as retail/consumer or corporate and transactional banking. Simple mathematics are at play here - i.e. a large amount of bonus monies, divided by just a few people.

Bonus proof yourself

Once this financial crisis is over, bonuses will probably continue to be allocated and paid based on similar parameters, although the actual risk of certain activities and their capital usage will be better understood.

Hence a smart banker today should take full advantage of this distribution method and quickly gravitate towards divisions with larger profit numbers, less staffing requirements and minimum usage of risk capital.

It's not a fair world and it's better to receive more than less. And when you get more, be smart and keep your large bonus a secret.

Do you agree with the author's thoughts on bonuses? Let us know below.