NEW types of allowance paid to bankers are nearly all in breach of the European Union's cap on bonuses and must be changed by the end of the year, it has been ruled.
The decision by the EU's banking watchdog, which has already capped the bonuses of high-earning bankers, raises the prospect major companies will have to increase basic pay or risk losing top staff, an expert said.
The EU rules on bonuses mean they cannot be more than basic pay, or twice that amount if shareholders approve.
But some banks have instead been paying role-based allowances. In August it emerged Royal Bank of Scotland, which is 81 per cent owned by taxpayers, had handed 10 executives a combined £3.4 million in share allowances in the eight months to the end of August under the scheme.
EU financial services chief Michel Barnier, who asked the European Banking Authority (EBA) to compile the report, said yesterday allowances sent a very bad signal to society that banks have not learned from the financial crisis or adapted their cultures.
"Compliance with both the letter and the spirit of the law is a prerequisite to restore trust and stability in our banking system," said Mr Barnier.
PwC consultancy said the ruling was at the most severe end of industry expectations and that the vast majority of big banks in the EU will need to change their pay policies.
Sources at UK banks said they would see how UK regulators apply the ruling, and it was unclear if bonuses covering 2014 performance and to be paid in 2015 are affected.
The EBA's board vote that ruled the allowances illegal and set a deadline for changes was not unanimous, the watchdog said.
The Bank of England, an EBA board member and whose Prudential Regulation Authority had endorsed the allowances as a "least worst" alternative to a cap, declined to say how it voted or whether it would apply the new EU guidance.
Mr Barnier said that, in principle, bonus payments handed out next year will be affected, adding the European Commission and the EBA will decide if enforcement action is needed.
Regulators in the UK gave allowances the green light as the British Government challenges the bonus cap in the EU's top court. Lawyers predict a scramble to revise pay contracts to meet the deadline as the bonus cap comes into effect on handouts due in early 2015.
Barclays, HSBC, Standard Chartered, JPMorgan, Goldman Sachs and Deutsche Bank have said they are among those paying allowances or planning to, with industry estimates putting the total number of bankers in receipt of them at about 10,000.
Under the EU law, remuneration must either be classified as variable and part of a bonus, or fixed. Banks say allowances come under fixed pay and are essential to retain staff in the face of global competition from New York and Singapore.
EU policymakers argued they are a ploy to circumvent the bonus cap and asked the EBA to investigate.
"The EBA have called a spade a spade," said John Thanassoulis, professor of financial economics at Warwick University.
"They have come down hard against this trick."
But he said banks would create more risks by increasing basic pay, leaving them potentially unable to cut costs quickly in a downturn.
Andrew Tyrie, chairman of the UK Parliament's Treasury Committee, said the bonus cap was fundamentally flawed and added: "It will encourage banks to up fixed pay rather than embed incentive structures that improve standards."
The EBA report found 39 banks that cover the bulk of European banking were paying "role based" or "market value" allowances, with the vast majority of role-based allowances breaching EU law.
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