Investment banking as we know it is slowly dying. The combination of very low interest rates and an onslaught of regulations has killed the traditional model that worked so well until 2008. EU regulation has capped excessive bonuses, but financial services pay still outstrips the vast majority of other industries. This has to change.
20 years ago, when a friend of mine started his career in banking, he told me that his grandparents had tears of joy in their eyes. Their grandson had a safe, secure job with a good salary in a reputable industry. They're probably crying again - but not tears of joy. Banking has become an industry that most people are trying to get out of.
Salaries are still high compared to other industries, but not as excessive as they used to be by any means. And the banking industry, which was under-regulated until the financial crisis in 2008, has been subject to a barrage of regulation by the EU since. One of the main reasons for this was the excessive bonus policy.
Even with the legal cap imposed in the EU in 2014, investment bankers can still earn up 100% of their salary as a bonus (or 200% with shareholder approval). Many firms have side-stepped the bonus cap by increasing base salaries and ensuring that overall pay remains high. Personal financial interests are therefore still one of the main reasons why most employees have chosen this career.
Bonuses are not the main reason crises continue to dog the banking system, but there remains a stubborn resistance to reducing employee costs within investment banking in particular. Investment banks will always pay their rock-stars as much as they can to avoid them departing for a competitor, but pay across the industry is still way too high. I believe that investment banks won't stop paying these big packages unless regulators intervene further, but the industry will push back against any further regulatory control.
If investment banking wants to survive as an industry, there are a few things that need to happen to pay in Europe.
1. Jobs need to leave London. London is the epicentre of European finance and one result of clustering talent is competition for talent and continued pressure on pay. If you look at the European Banking Authority's report into high earners, London is where you go to get paid big bucks. 75% of those earning more than €1m in European investment banking reside in the UK. Investment banks are already realising that back, and now middle, office jobs don't have to be based in London to be performed effectively. Highly skilled employees in places like Poland and Hungary are doing the same jobs for a fraction of the price.
It's also generally accepted that since the Brexit vote, London will be a smaller financial centre. One of the results of this will be the dispersion of talent across Europe and this will result in lower pay. Banks are not moving people across to the likes of Frankfurt, Paris or even Zurich and Madrid - they're moving jobs. Many will use this as an opportunity to pay their employees less than they did in London.
2. The pyramid will no longer be inverted. 'Juniorisation', namely replacing expensive senior employees with juniors who can be trained up, is the new trend in investment banking. If investment banks are serious about cutting costs, then this will need to continue. To some extent, the pyramid has been inverted at investment banks for too long - there have long been too many people stagnating in the middle ranks and too many people at the top. This promotion of younger people who banks can pay half the salary to perform the same job is a trend that's here to stay, and banks will have to be more systematic about clearing out the senior ranks of people who are highly-paid, but add little value
3. Pay needs to fall by 20%. Investment banks need to reduce over all pay by 20% over the next five years. This may not sound like a huge proportion, but reducing salaries is not something that comes naturally to investment banks. They need to make the cuts.
4. Deferral periods will get longer. Investment banks need to reward people for the long-term financial success of the organisation, not for short-term gains. Bonus deferrals have become much more prevalent, particularly for 'material risk takers', or those that earn over €500k. But these need to get longer. Deutsche Bank, for example, said this year that more than 75% of variable pay between €200-500k will now be deferred for up to four years (instead of three). The minimum is currently three years, but regulators are proposing to increase bonuses deferrals for up to 10 years. Expect this to become the norm.
5. Fintech will drive down salary costs. Last year the rise of fintech start-ups was seen as a threat to the traditional banking model. Within the past 18 months, these firms have transformed into a potential source of partners. Fintech companies are investing quickly and solving problems that face investment banks. Blockchain is a good example of how start-ups are moving at a faster pace than larger firms. Inevitably, this will mean that previously manual tasks are automated and this will drive down employee costs.
Conrad Pramboeck is Head of Compensation Consulting at the Executive Search firm Pedersen & Partners