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Banker bonus cap: What will happen if Kwasi Kwarteng scraps it?

UK chancellor Kwasi Kwarteng is said to be mulling lifting a cap on banker bonuses. Photo: Leon Neal/Getty
UK chancellor Kwasi Kwarteng is said to be mulling lifting a cap on banker bonuses. Photo: Leon Neal/Getty

Kwasi Kwarteng is reportedly considering scrapping a cap on banker bonuses as millions struggle to keep up with the rising cost of living.

The UK chancellor of the exchequer has come under fire for the controversial move that underlines Liz Truss’s determination to introduce major post-Brexit reforms to the City of London.

Kwarteng believes the change would make London more attractive for global banks, the Financial Times, citing people familiar with the matter, first reported.

However, the Bank of England has said increasing salaries when prices are running at almost five times its 2% target could spark a wage spiral, and former chancellor Rishi Sunak said it's inflationary.

It comes as the labour market shows signs of tightness as unemployment fell to the lowest rate since 1974, but real term pay still lags inflation as wages fell 2.9%, according to the Office for National Statistics (ONS).

Separate ONS data also found medium pay for the finance and insurance sector rose by 13.4% last month — the highest jump — while those working in education saw the lowest rise at 2.1%.

So as incomes fall behind inflation and the cost of living surges, what will removing the cap mean?

Offices of HSBC, Citi, JP Morgan and Barclays banks in London. Photo: Victoria Jones/PA An aerial view of the offices of HSBC, Citi, JP Morgan and Barclays banks in Canary Wharf, east London. (Photo by Victoria Jones/PA Images via Getty Images)
Offices of HSBC, Citi, JP Morgan and Barclays banks in London. Photo: Victoria Jones/PA

What is the banker bonus cap?

The cap on bankers' bonuses was introduced by the European Union in the wake of the global financial crash in 2008, and was made law in 2014.

The rule remained in place despite the UK officially leaving the bloc in January 2021.

Following Brexit, it was thought that Britain would scrap the rules to lure bankers and boost the City, but fears of a public and political backlash has meant it hasn't happened yet.

In June, former prime minister Boris Johnson's government reportedly considered removing the cap, before Johnson was forced to say he was not planning to lift the cap.

Kwarteng however has taken a more decisive stance. Earlier this month, in a meeting with industry leaders, the chancellor said the new government under Truss will pursue sweeping financial reforms to unleash growth and competitiveness.

"The prime minister and I are committed to taking decisive action to help the British people now, while pursuing an unashamedly pro-growth agenda," Kwarteng said in a statement after the meeting.

Read more: HSBC's lowest-paid workers given £1,500 to help with cost of living

How does the cap work and what will be the impact if its scrapped?

Under the cap, banks have to pass a shareholder vote if the bonus is more than the employee’s salary.

There is also a hard limit on the annual-payout — at no more than two times a banker's salary.

Prior to the introduction of the rules there was no limit in place.

Major banks like JP Morgan and Chase (JPM) and Goldman Sachs (GS) are likely to welcome any post-Brexit change and the lifting of the cap as it allows them to align their pay practices in London with the US.

The US still allows big bonuses in the sector and the move will reportedly boost the economy by attracting high performing bankers to the City of London as opposed to seeking overseas pastures.

UK banks with big investment bank operations including Barclays (BARC.L) are also likely to benefit from it.

Kwarteng is due to announce a mini-budget on 23 September to help the country as it faces soaring bills stemming from Russia invasion of Ukraine.

But it is unclear whether an announcement on bankers’ pay would be part of his first fiscal announcement or be part of a wider package later on.

Why is it sparking controversy?

Some argue that uncapped bonuses could lead to the kind of risk behaviour that spurred the 2008 financial crisis.

The 2008 financial crisis had been caused, in part, by a generation of bankers whose big bonuses had given them an incentive to take the kinds of risks that cause a meltdown in the global banking sector.

But the bigger crisis is falling real term pay for many workers including nurses and other frontline workers.

Economists and unions were among those criticising the timing of the proposal as bonuses in the banking sector still reached record highs with the cap in place.

Luke Hildyard, the executive director of the High Pay Centre think tank, called the move an "ideological measure" that favours the rich.

He added: "The bonus cap has probably helped to contain bankers’ pay awards but they’ve still reached record highs this year while the rest of the country has undergone an epic cost of living crisis and profound economic hardship.

"Removing the cap would be a pro-rich ideological measure that sends a depressing message about who policymakers listen to and think about when making economic policy."

Read more: UK inflation unexpectedly falls to 9.9% as fuel prices ease

Speaking to BBC Radio Four's Today programme, former BoE policy maker Andrew Sentance said lifting the cap on banker bonuses would jar with efforts to rein in inflation.

Sentance who was a member of the Monetary Policy Committee during and after the financial crisis said the "timing would be very bad".

"It sends a rather confused signal when people are being squeezed by the cost of living and the government is encouraging pay restraint," he said Thursday.

Bank governor Andrew Bailey, last year said that changing the bonus limit was not a "high priority", calling it a "bad policy" in 2014, proposing clawing back bonuses from rule-breakers as a better way to police risky behaviour.

TUC General Secretary Frances O’Grady said: "Working people are being walloped by soaring prices after the longest and harshest wage squeeze in modern history.

"The chancellor's number one priority should be getting wages rising for everyone – not boosting bumper bonuses for those at the top."

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