Top European Union officials have agreed to slap a strict limit on bankers' bonuses, which have been blamed for encouraging the risk-taking behaviour that triggered the financial crisis.
The move is part of a broad package of financial laws that includes requiring banks to hold more capital reserves in an effort to shield taxpayers from having to pay for more expensive bailouts.
Bankers' bonuses will be limited at a maximum of one year's base salary and will only be allowed to reach twice the fixed pay if a large majority of a bank's shareholders agrees, Othmar Karas, the European Parliament's chief negotiator, said Thursday.
Huge pay packets
Top bankers and traders may currently earn bonuses multiple times their salary based on their performance, given that there is no legal pay limit yet. But public outrage has grown across Europe over large bonuses for executives of banks that received huge state bailouts during the financial crisis.
While agreement was broadly expected on the new capital reserves, the so-called Basel III rules, the bonuses issue was more contentious. Agreement was reached late Wednesday's after an eight-hour make-or-break negotiating session between EU lawmakers, the EU Commission and the bloc's 27 governments in Brussels.
"This overhaul of EU banking rules will make sure that banks in the future have enough capital, both in terms of quality and quantity, to withstand shocks. This will ensure that taxpayers across Europe are protected into the future," said Ireland's Finance Minister Michael Noonan, who led the negotiations for the governments.
Some details for the corresponding legal texts — the package is more than 1,000 pages thick —still have to be hammered out, but the final approval by parliament and government leaders of the package is expected to be a formality, ensuring the laws come into force next year.
'I don't think bankers should be treated as special creatures ' —RBS chief Stephen Hester
One sticking point is that under the provisional agreement, the bonus cap will also be mandatory for European banks' employees overseas, for example in New York — a point that particularly irks Britain, which is home to Europe's biggest financial industry.
"We need to make sure that regulation put in place in Brussels is flexible enough to allow those banks to continue competing and succeeding while being located in the U.K.," British Prime Minister David Cameron said during a visit in Riga, Latvia.
Britain had initially opposed the bonus cap proposal, saying the rules will drive away talent and hamper growth. It tried to rally other EU governments behind its position, but failed to garner enough support, primarily because many governments felt the fight over the bonus cap wasn't worth delaying approval for the more important Basel III rules to come into force by January 2014.
Proponents of the bonus cap say the payments encouraged bankers to take massive risks at the expense of the long-term future of their businesses, which helped to destabilize the financial system.
"Overall, this is a major achievement for Parliament, in curbing the culture of quick profit and irresponsible lending that has played such a pernicious role in fuelling Europe's banking crisis," said Sharon Bowles, a European lawmaker of the British Liberal Democrats.
It is unclear how many executives of European banks will be hit by the new rule. Lawmakers estimate the cap would hit about 500 staff members at a large international bank such as Germany's Deutsche Bank, and probably a few thousand in London.
London dislikes move
"The most this measure can hope to achieve is a boost for Zurich and Singapore and New York at the expense of a struggling EU," said London's Mayor Boris Johnson, whose city's economy greatly depends on the financial industry.
Other critics of the bonus cap have warned that it will only push banks toward increasing their employees' base salary. The German banks' association criticized the rule as a diktat that strips bank owners of their right to set pay levels in their companies.
Stephen Hester, the chief executive of Royal Bank of Scotland, which was bailed out by British taxpayers, struck a more cautious note.
"I don't think bankers should be treated as special creatures in any way to tell you the truth," he told the BBC. "Perhaps one of the problems of the past was bankers got to the point where they thought they were special creatures. I think we should apply rules to everyone whatever those rules may be."
The new capital rules in the financial reform package require all banks to gradually increase their capital reserves over the coming years to stabilize the financial sector across the EU's member states, which together form the world's largest economy.
The world's largest economies, including the U.S., have committed to adopting the Basel III rules. They are part of a global effort to prevent another shock to the financial system like that prompted by Lehman Brothers' 2008 collapse, when banks were highly leveraged while enjoying low capital requirements. The lack of solid financial cushions meant that many banks were vulnerable, and eventually required taxpayer-funded bailouts to avoid bankruptcy.