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EU CAPS Bank Bonuses: Company Performance To Dictate Bonus Pay

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BRUSSELS — European Union lawmakers have voted overwhelmingly to cap bankers' short-term cash bonuses from next year, a move that European leaders hope other parts of the world will follow.

Members of the European Parliament voted 625-28 in favor of the new rules which will become final when they are approved by EU finance ministers as expected next week.

From 2011, bankers will only be able to get part of their yearly bonuses in cash upfront. The other 70 percent will be held back and paid out if the company performs well.

The caps come after a European outcry over payments to executives of banks that received huge state bailouts during the financial crisis. Some say bonuses encouraged bankers to take massive risks at the expense of the long-term future of their businesses.

Michel Barnier, the EU's financial services commissioner, said the new rules sent a strong message that "there will be no return to business as usual."

"Banks will need to change radically their practices and the mentality that have led in many cases to excessive risk-taking and contributed to the financial crisis," he said.

Starting next January, cash bonuses will be capped at 30 percent of the total bonus and 20 percent for "particularly large" bonuses. The measure leaves it to individual governments to determine what "particularly large" means in their economies.

While some European countries including Britain have already imposed limits on banker bonuses, the new rules set minimum caps for all 27 members of the EU. French and German governments have also effectively set caps by pressing banks to agree to limit executive pay.

On the other side of the Atlantic, the U.S. Federal Reserve, in an in-depth analysis released last month, found that many U.S. banks' compensation practices were deficient in curbing excessive risk-taking. The Fed – and other major banking regulators – under a newly adopted plan can veto pay policies that cause too much risk-taking by executives, traders, loan officers and other key employees.

"We found that many banks had not modified their practices from what they were before the crisis," Fed Chairman Ben Bernanke told a House panel last month. "The structure of the compensation practices needs to change so that there's not an incentive to take excessive risks, you know, packages where the trader gets all the upside and none of the downside. That's the kind of thing we're trying to get rid of," he said.

In Europe, a large part of the bonus will have to be deferred, though it is up to governments to determine for how long. At least half of the total bonus will be held as "contingent capital" for banks to call on first if they urgently need funding.

The measure also limits "exceptional pension payments" to avoid the kind of bloated severance packages for disgraced departing executives that have caused public uproar around Europe.

Douglas Elliott, a fellow at the Washington DC-based Brookings Institution and former JP Morgan investment banker, says he doesn't think the new rules will force bankers to quit Europe.

"There will be some effect, but generally bankers will continue to act the same way," he said. "It will have the least effect on the wealthiest ... the people who will be hurt are the investment bankers who actually need the cash."

European banks will also be required to hold a minimum amount of capital to ensure they are covering risk from their trading book and complex securitized investments – such as mortgage-backed securities – to avoid a repeat of risk-related losses like those seen during the financial meltdown. The capital requirements will take effect in 2012.

This could force banks to hold three to four times more capital against their trading risk than they do at present. Barnier, however, insists there would be an upside because the tougher requirements would help make the banking sector better able to cope with shocks.

Global banking regulators are also separately drafting tighter capital requirements that European banks complain could force them to put aside far more money to counter risks. They say this could hit their profits and even force them to curb lending to companies and households.

Associated Press writers Jeannine Aversa in Washington and Rafael Mesquita in Paris contributed to this story.

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