FSA hint at increases in prudential capital requirements to curb city bonus culture

15 September 2008

Did the city bonus culture cause the crunch? The chief executive of the FSA seemed to think so and hinted at tightening of prudential capital requirements to prevent it happening again.

In a classic example of trying to close the door after the horse has bolted, Hector Sants (chief executive of the FSA) hinted at tightening prudential capital requirements in a speech to the Investment Management Association on 20 May 2008.

Banks, insurance companies and investment managers may be breathing a sigh of relief at the subsequent silence but what lay behind the comments is the suspicion that these institutions got their remuneration policies badly wrong by paying large cash bonuses for short term performance.

Mr. Sants emphasised the need for a more balanced approach to remuneration policy and, in particular, the need for tried and tested long term share-based awards (which are typically measured over a performance period of at least 3 years).

Prudential capital is the minimum value and quality of assets which regulated business are required to hold by the regulator, given their level of financial risk, in order to protect the financial system and the public. The FSA can require banks and other regulated businesses to increase their prudential capital. If the FSA were to increase these requirements in order to force regulated companies to alter remuneration policy this would have a major impact at a time when these institutions are struggling to recover their balance sheets.

The Chancellor of the Exchequer seems to think these matters should be left to the market but the Association of British Insurers may not be keen as many of its members are FSA regulated.

We expect to hear much more on this head. The financial news today is dominated by the collapse of Lehman Brothers but last December its staff were reported to be celebrating record bonus payments, of which about two-thirds were paid in shares. Now that Lehman has filed for bankruptcy protection, there are murmurings that those bonuses might be recoverable as fraudulent transfers, on the basis that Lehman was not “solvent” when it paid out the bonuses.

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