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The Big Bucks and Bonuses at Banks Won’t Last

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Soaring pay and bonuses came as an unwelcome shock to shareholders during U.S. banks’ 2021 earnings season. Most big European banks are also likely to complain about the exploding cost of talent in their results over the next few weeks.

The big worry for investors — after the best banking profits in years — is that pay profligacy today will bake in higher costs that are harder to shed when trading and dealmaking inevitably slow. There are already signs that the market for new listings is sputtering to a standstill.

But headline pay gains mask a subtler picture beneath. The past decade has seen creeping changes in the kinds of jobs bankers do and the way many of them are paid. Even at Goldman Sachs Group Inc., the vast majority of its 45,000 staff are now compensated more like everyone else — with a regular paycheck — than like bonus-chasing investment bankers, according to Chairman and Chief Executive Officer David Solomon.

That has helped cut the cost of pay as a proportion of revenue – the compensation ratio – from an average of nearly 40% in 2011 to 36.5% last year for the big five U.S. banks plus Deutsche Bank AG, which reported full-year results last Thursday. Most of that decline is accounted for by Morgan Stanley and Goldman Sachs.

Some of that change is due to the big recovery in revenue over past couple of years. But until 2021, the average cost per employee at some of the biggest U.S. banks had stagnated for several years. In Goldman Sachs’s case it had been falling.

There are several things going on. Those in the most privileged positions are still showered with insane rewards: Some of Goldman Sachs’s top traders were expected to get more than $30 million for 2021, Bloomberg has reported, while Solomon himself pulled down $35 million, double his pay last year, although he was docked $10 million in 2020 as a penalty for the firm’s role in Malaysian 1MDB investment fund scandal.

But amid high competition for the most in-demand staff on Wall Street, banks are employing tactics designed keep the costs of these people flexible in future.

During previous booms, executives seduced their targets with guaranteed bonuses, sometimes for several years. That hasn’t been happening this time, according to headhunters and bankers. Instead, banks have focused resources on retention rather than recruitment, bidding people to stay with promotions and promises of rapid careers development, sweetened of course with extra money.

“Counter-offers are very generous,” said Michael Karp, CEO of Options Group. “The best people are retained at a premium with a much larger bonus than whatever the competitor was offering for the first year.” 

Such offers can be guaranteed, but only for one year – then it’s back to eating what you kill, as they say. However, for those who earn the guarantee, the higher total pay will be the starting point for the following year’s negotiations. That is inflationary.

But some banks are also trying to guard against broad inflation among the highest paid by characterizing some payouts in 2021 as windfalls from a very fruitful year rather than as bonuses that should influence what they expect next time. Goldman Sachs is doing this with special share-based bonuses for its partners – the highest ranking 1% of staff in the company.

Similarly, Credit Suisse Group AG is creating a one-time share-based bonus for all experienced bankers in the managing director and director ranks, which will pay out in the longer term if the bankers stay and Credit Suisse recovers from its current malaise. That’s designed to keep people committed to a tough and long-lasting turnaround that could include less competitive bonuses along the way.

Credit Suisse is also conditioning some of its upfront cash bonuses for staying at the firm — if people leave within three years they must repay a portion. This isn’t just in banking: Law firm Freshfields Bruckhaus Deringer is paying its private-equity specialists an extra bonus that can be clawed back if they leave within a year, according to the Financial Times.

Broader inflation is lifting salaries for the greater number of lower-paid people, for example in retail branch networks. Some of JPMorgan Chase & Co.’s lowest-paid people got “merit increases” to salaries last year that cost the bank $1 billion, or 2.6% of its total pay bill. But these also sound more like special deals than repeatable raises.

Across the industry, extra benefits and big salary boosts for junior investment bankers and traders have been well documented, but there is some element of catch-up. No doubt younger bankers are paid very well compared with most other industries, but their older peers say compensation hasn’t changed much in dollar terms since before the global financial crisis in 2008.

Advising on takeovers and fundraising is always going to be a volatile business and pay for the most in demand rainmakers will fluctuate. But throughout trading businesses, more algorithms and electronic trading and less risk taking mean fewer human traders swinging for the fences and huge bonuses. Revenue should be more stable and compensation costs lower and less volatile, too. 

If 2022 turns out to be another boom year for bankers, it will be harder for executives to resist the worst pay practices that bake in less flexible longer-term costs. But, on balance, investors ought to take some comfort that for now banks seem to be guarding against excessive inflation.

More From Bloomberg Opinion:

• The Bonus Boom is Up Against a Shareholder Wall: Marc Rubinstein

• Bonuses Feed a Bull Market in Bragging Rights: Paul J. Davies

• Junior Bankers Have Been Underpaid for Too Long: Jared Dillian

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. He previously worked for the Wall Street Journal and the Financial Times.

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