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When European banks were told by regulators to restrict bonuses, they found an easy way around the rules: raising investment bankers’ salaries, sometimes by as much as 100 percent. Now that decision may force them to step up layoffs and consider eliminating some bonuses entirely as they seek to reduce costs.
With revenue shrinking and expenses rising, banks including UBS (UBS), HSBC Holdings (HBC), and Credit Suisse Group (CS) have announced more than 70,000 job cuts since midyear, compared with 42,000 by U.S. peers, according to data compiled by Bloomberg. More layoffs may be on the way as companies struggle to maintain those higher fixed salaries. The real action of cost-cutting will be around bonus pools and headcount,” says Tom Gosling, a partner in the rewards practice at PricewaterhouseCoopers in London.
Banks must balance cost control with the need to retain talent. Reducing regular pay is not an appealing option. “The absolute last thing banks will want to do is cut current salaries unless they have an explicit contractual right to do so,” says Jason Butwick, a London employment attorney at law firm Dechert. “The legal, reputational, commercial, and logistical risks of going down that route are huge.”
While banks can ask employees to accept pay cuts, they can’t impose them easily if bankers refuse, Butwick says. Under U.K. employment law, any firm looking to reduce the salaries of more than 19 people must go through a 90-day waiting period, during which employee representatives negotiate on their behalf. That means any effort to cut pay is likely to be made public and reflect badly on the bank, he says. Salary reductions could cause “an enormous public-relations problem,” says Mark Mansell, an employment lawyer at Allen & Overy in London.
The banks are facing slower economic growth and a debt crisis. Combined revenue for the 20 largest global investment banks was down 8 percent in the first half of the year after a 23 percent drop in the same period last year, Barclays Capital (BCS) analysts wrote in an Aug. 10 report. The 46-company Bloomberg Europe Banks and Financial Services Index has fallen 36 percent this year through Sept. 13.
Compensation cost as a percentage of net income at the largest investment banks will increase for a second year, climbing to 65 percent in 2011 from 55 percent in 2009, Barclays Capital estimates. It could be more than 80 percent at the investment-banking units of UBS and Credit Suisse, the analysts said. The rise in fixed costs is driven by the raises doled out after European regulators, including those in the U.K. and France, restricted when and in what form bankers can be paid. The theory was that reducing bonuses would help rein in risk-taking by bankers hoping to boost compensation by posting short-term gains. The average base salary of a managing director at a global investment bank in London has surged to between £300,000 ($474,480) and £500,000 from £175,000 to £250,000 three years ago, says Jason Kennedy, chief executive officer of Kennedy Group, a London-based search firm.
Salary and deferred bonuses “are now about 70 percent to 80 percent of overall total compensation,” says Jonathan Nicholson, managing director of Astbury Marsden, a London executive search firm. “The only material way to make a difference in flexing costs is to cut jobs.” Spokesmen for UBS, HSBC, and Credit Suisse declined to comment on plans to reduce costs through reductions in jobs or pay.
Banks could have given themselves more flexibility by inserting a clause into contracts allowing them to reduce base salaries after a set period or in the event of a decline in trading conditions. Goldman Sachs (GS) is one of the few banks to have done that. The company will cut the salaries of some London employees who received temporary increases in 2009, a person with knowledge of the matter said last month.
Lloyd C. Blankfein, Goldman Sachs’s chairman and CEO, warned against raising base salaries on Wall Street in a June 16, 2010, interview with staff of the U.S. Financial Crisis Inquiry Commission. “Salary is another form of guarantee, so we would like low salaries and high contingent comp,” Blankfein said at the time, referring to compensation based on performance. “We think the world is going in a poor direction.”
The bottom line: Having raised some salaries as much as 100 percent, European banks now may have to cut jobs to lower compensation costs.