BASEL & GRONINGEN – Banks should be thinking about changing their compensation structures to improve their risk profile, said Nout Wellink, president of the Netherlands Bank and chairman of the Basel Committee on Banking Supervision (BCBS), in a speech at the University of Groningen in the Netherlands.
Wellink stressed the role of incentivisation as a root cause and solution to the credit crunch. “Misguided incentives are often also at the root of growing imbalances, because of conflicting micro and macro perspectives,” he said. “This is because at the micro level, market participants tend to take the environment in which they operate as given, for instance prices and the behaviour of other market participants. But factors that are considered exogenous at the micro level may become endogenous for the financial system as a whole.”
“Employees who receive massive bonuses when earnings are high but are hardly hit when losses are made, are probably less prudent than would be in the interest of their employer,” he continued. “This not to say that bonus systems are by definition wrong, but they should be designed in such a way that curbs exist on inappropriate behaviour. Perhaps one way to improve this is to ensure that an employee’s time horizon is aligned with that of more general interest, for instance by making bonus payments dependent on broad performance indicators over a longer period.”