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One of the main priorities of Chancellor Kwasi Kwarteng in the ‘mini Budget’ was to boost growth against the backdrop of a global recession. With the UK having the lowest level of investment among the G7 countries, one controversial way in which Kwarteng has attempted to boost it is through the removal of the banker’s bonus cap, which would, arguably, increase investment in London and keep it competitive with other global financial hubs.

The banker’s bonus cap was introduced in 2014 by the European Union, with immediate criticism from the UK government; then-Chancellor George Osborne argued it would have a ‘perverse’ effect on the economy. The intended effect was to stabilise the financial system by shifting employee pay from variable bonuses to fixed salaries and therefore shifting the priorities of banks from short-term gain to long-term investments and lessening risk-taking.

Yet, the impacts on the economy were not as significant as hoped; a report by the European Banking Authority suggests there has been ‘no real impact’ on institutions’ financial stability, while also noting that the percentage of high-earners (those who earn 1 million euros or more per financial year) at these institutions rose from 59% in 2013 to 87% in 2014. This trend suggests that the removal of bonus caps may even lead to a slight fall in fixed salaries for many bankers, especially as job losses and salary cuts are forecast this year. Yet the real effect for many in the financial sector will be minimal, as these falls will simply be offset by higher bonuses.

Perhaps the most certain impact will be the greater level of flexibility for banks when faced with economic downturns such as the current one. Banks will now be able to adapt to changing economic conditions by varying the levels of their bonuses, decreasing and increasing them dependent on revenue. With this reduction in fixed costs, some could argue that the cap being scrapped may even benefit those who are currently at risk of losing their jobs at banks— as banks could choose to lower their salaries rather than simply cut jobs. This situation is not ideal, and it has led some bankers to criticise the potential move, but a fall in salaries is slightly preferable to mass job losses.

A potential impact of the cap removal, touted by Kwarteng, is that it would make London a more attractive location for investment from financial companies. Contrary to predictions of a mass flight to Continental Europe by banks following Brexit, the majority of firms have stayed put. London continues to top global financial centre rankings and European centres such as Frankfurt are far from overtaking it. Rather, London should fear competition from Asia and US centres such as New York and Singapore, which have recently been outdoing the UK in attracting skills and talent. By deregulating bonuses, London could compete with US financial hubs and strengthen its current position. Similarly, as the cap removal would apply to all employees of UK-based banks, it could also help British businesses with extensive operations abroad, such as Barclays and HSBC.

Finally, a key concern repeatedly voiced is that the removal of the cap is something of a return to pre-2008 policies, when unregulated banking caused one of the biggest economic shocks of recent memory. The cap in and of itself did not improve financial stability, as reports have shown, and regardless, London’s bankers have remained highly paid. But it may cause issues in once again encouraging short-term risk taking over long-term stability, as some have suggested

The regulatory infrastructure, however, is very different now than to what it was in 2008. The defunct Financial Services Authority (FSA) has been replaced by the more specialised Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), and the memory of the 2008 crisis still looms large in the eyes of policymakers and regulators alike. As long as financial regulatory services themselves are not weakened, and as long as the economy still recovers from the COVID-19 pandemic, the risk of a crisis such as what was seen in 2008 remains low.

Overall, the removal of the bankers’ cap, though it may be incredibly poorly timed, is not as destabilising or misguided as has been implied. Whether the policy will go far in injecting life back into an economy with rising interest rates and inflation and low growth, remains to be seen. It may help London’s financial institutions recover against the backdrop of the Russian invasion of Ukraine and the aftermath of the COVID pandemic, but the extent to which it would impact the wider economy, especially as a standalone policy, seems relatively small.

Jonas is currently undertaking work experience at Bright Blue. Views expressed in this article are those of the author, not necessarily those of Bright Blue. [Image: Tetyana Kovyrina]