
Why regulators should focus on bankers’ incentives - bostik
https://bankunderground.co.uk/2017/04/05/guest-post-why-regulators-should-focus-on-bankers-incentives/
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jackgavigan
"Responsibility is a unique concept: it can only reside and inhere in a single
individual. You may share it with others, but your portion is not diminished.
You may delegate it, but it is still with you. You may disclaim it, but you
cannot divest yourself of it. Even if you do not recognize it or admit its
presence, you cannot escape it. If responsibility is rightfully yours, no
evasion, or ignorance, or passing the blame can shift the burden to someone
else. Unless you can point your finger at the person who is responsible when
something goes wrong, then you have never had anyone really responsible."

– Admiral Hyman G Rickover, United States Navy

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vostok
Bankers are slightly more sophisticated estate agents and they have similar
incentives. The basic business model is to do a lot of free work upfront in
exchange for a shot at being massively overpaid for relatively simple work.

I think the main problem is a classic principal/agent situation. The person
who hires the bankers is often paying with someone else's money. This is
really no different to other forms of enterprise sales.

I think both are massively corrupt, but there seems to be a disproportionate
amount of breath wasted on bankers as compared to other salesmen.

~~~
mannykannot
> There seems to be a disproportionate amount of breath wasted on bankers as
> compared to other salesmen.

Putting aside the question of how valid the analogy is, banking deserves the
focus because of its importance to society, and the degree of harm it could
cause.

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vostok
How does banking cause more harm to society than, say, construction or
databases or cars?

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arcanus
Neither databases nor the construction industry are leveraged 10x+.

Neither provides fundamental utility to other sections of the economy through
lending activity, which can result in liquidity events at otherwise perfectly
solvent firms.

Neither can drive prices in other sectors through speculation in financial
instruments or through financial reporting and reporting downgrades.

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al_chemist
> Neither databases nor the construction industry are leveraged 10x+.

Maybe banking shouldn't be either?

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thedufer
How much leverage is the right amount? Regulators seem to think it is
somewhere around 10x.

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mjevans
It's probably context dependent; which is why it's //critical// to never lie
about, cover up, or over-simplify that context. In my opinion, doing that is
quite nearly as bad as murder. At the very least doing such things should bar
someone guilty from working in the industry for many decades.

"The right amount" then is when expected losses are less than expected
profits; with some safety factor. This is complicated by allowance for both
rare really bad sets of loss all at once and absorbing losses over a longer
time. I think the solution for both is insurance. In fact, I really hope that
the US FDIC (mandatory insurance for deposits, though it hasn't kept up with
inflation) represents the basic insurance for the 10% figure you quote.

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Maarten88
As long as risks are financial only, they will just get insurance against it
and still get away with the current risk-taking behavior, passing the costs to
the customer.

Criminal punishments (jail time) might work. I think that taxing transactions
in financial products would help a lot more, making the finance industry
smaller, which I think would be very beneficial to society.

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VHRanger
Making the finance industry smaller would not help society, because it would
make lending more expensive. That would mean more expensive mortgages, more
expensive loans, less VC funding, etc.

Making big banks smaller also will not help socially because banks have
returns to scale in diversification. So bigger banks are less likely to fail
by themselves, and can lend for lower rates, which is socially good (recent
research [1] [2] indicates this might not be true for the biggest banks --
they exhausted benefits of scale).

Now one might ask if "too big to fail" effects might incentivize the bigger
banks to act recklessly and counteract the above benefits? The answer is that
there's the evidence does not back that up [3] at least for 2008 [4]. But that
doesn't mean it is or is not the case going forward.

Why did banks act so recklessly if they were not acting on too big to fail
incentives, then? The answer, like in the OP, is management incentives. The
managers could not give less of a fuck if the bank failed, because they were
incentivized by shareholders, in the form of bonuses, etc. to generate large
year-over-year profits. And in any market close to efficient, the only way to
do that is to take on large risks.

Not only did the managers not lose money if the bank failed, they didn't have
any personal risk whatsoever. The lead up to 2008 was perfectly strategically
rational coming from a bank manager's point of view.

As the poster above me says, one way to fix that is to impose penalty from the
judicial system. There's only so much financial regulation can do. But DoJ has
been awful at that, even clearly criminal acts (remember HSBC?) doesn't send
management to jail.

[1]
[http://commons.colgate.edu/cgi/viewcontent.cgi?article=1053&...](http://commons.colgate.edu/cgi/viewcontent.cgi?article=1053&context=econ_facschol)

[2]
[https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2655448](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2655448)

[3]
[http://fic.wharton.upenn.edu/fic/papers/11/11-47.pdf](http://fic.wharton.upenn.edu/fic/papers/11/11-47.pdf)

[4] Remember the official fed policy was not to bailout banks coming into the
crisis. They let the first behemoth fail, but quickly realized the disaster
that awaited the global economy if they let the next one fail.

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markvdb
Yes, a smaller financial sector would make lending more expensive. But would
that be a bad thing, socially speaking?

A smaller financial sector would stabilise the financial and economical
system, albeit at a lower level of economic activity. The less rich and
powerful suffer most from economic instability. They also stand to gain most
from increased stability. Ask people from the Baltic states about what
happened in 2008-2009...

Who is the biggest beneficiary of credit? Us, the rich and powerful!

Have a look at the most expensive thing most people ever buy in their lives: a
house! Housing prices and interest rates are directly linked. More expensive
lending would mean lower housing prices. To some extent, deflating that bubble
is actually a good thing for the less rich and powerful!

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ori_b
> More expensive lending would mean lower housing prices.

That benefits people who can pay in cash. Otherwise, the difference in price
goes​ to the bank as interest.

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MR4D
Might also want to note that it negatively affects borrows.

Especially those who are underwater on their home loan.

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jernfrost
I fundamentally disagree with the ideas of this article and think it is a
wrong and harmful way to go about the problems in banking. It will create a
dangerous precedence for other industry. The premise is based on a flawed
homo-economomics understanding of human psychology. It is classical right-wing
libertarian thinking, where the assumption is the only incentives driving
people are greed and fear of punishment. These so called incentives are all
stick and no carrot.

People should be given a reason to do the right thing. Quite the contrary they
are usually punished for doing the right thing. Whistle blowers have poor
protection. Responsible employees get worse results than the reckless ones and
thus get passed over on promotions or hounded by their managers.

It would be much more effective to simple get rid of all the incentives
designed to only measure financial performance and nothing else. Pay people to
do a good job, rather than according to a narrowly defined metric of
performance.

The measurement based, new management style way of doing things has been
poison everywhere in society not just banks. It causes police to arrest people
just to fill their quota. Parking guards to write out tickets to meet target
for number of tickets written by management. It makes hospitals push for
unnecessary medical procedures.

It is time to stop treating people like greedy robots, and actually accept
that people are blessed with compassion and the ability to make complex
decision. They will do that if you let them, rather than rewarding them for
being reckless idiots.

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Pyxl101
This is unrealistic. How do you measure whether someone "does a good job"?
What if their job is to earn money while taking a certain amount of risk? This
is ultimately what all banks do: all loans have a risk they won't be paid
back, and the job of the bank is to earn money while managing that risk.

I think if you tried to refine these ideas into something more specific and
concrete, that would apply on a daily or yearly basis with respect to employee
performance and compensation, you'd see that this idea needs to be a lot more
fleshed out. You haven't considered how incentives play out at multiple levels
in an organization or how to construct the right ones.

There is no such thing as "just pay people for doing good work". The world
doesn't have a ruler that can decree this and if it did there's still no way
to enforce that it happens. You need to think about how to structure
incentives for each person in the organization so that they shape behavior in
the right direction. Personal liability is an incentive. "Pay people for doing
good work" is not an incentive nor a policy that can be directly implemented.
It is at best a goal that could be refined into policy and incentives after
defining what exactly it really means. (What is "good work" and how do you
know it when you see it?)

The author of the article is advocating for creating a much stronger incentive
to do the right thing by making people who work at banks personally liable for
the outcomes of their decisions. The author specifically makes the point that
people outside the system don't how to recognize "good work", but people
within it do, and by making them personally liable, they will think twice
before doing bad work.

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branchless
Hard to disagree however it's the BoE blog and the BoE is responsible for this
regulation. However their policy is to make the UK into the biggest finance
cesspit imaginable in order to try and siphon off surplus value globally.

There has been very little action against banks despite continuous fraud in
the UK. Yet we have dawn raids for bank employees who go "rogue".

The UK's only "industry" is banking. Their unique selling point is that you
can come here and do whatever you like so long as you launder most of it
through land to continue the UK fire sale to forestall total collapse.

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saalweachter
I feel like there's some sort of parallel with the Machine Apocalypse.

"What if we build intelligent machines that execute their goals at the expense
of humanity," we worry.

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yuhong
Thinking about it, if you are going to print money, credit is probably one of
the worst way to do it. Even something like basic income has its problems.

