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Project Merlin should be quietly allowed to expire

Bank bonuses | Project Merlin should be quietly allowed to expire Ian Fraser

Project Merlin, the wizard scheme dreamt up in autumn 2010 by the ex-Barclays chief executive John Varley and RBS chairman Sir Philip Hampton, in the hope of appeasing the government and drawing a line under “banker bashing”, has descended into farce.

The project started with the bankers' hope that, if they showed some personal “restraint” where bonuses are concerned, they might be able to magic away their post-crisis reputation as social pariahs. They also believed the government might reward them for their parsimony by removing some of the uncertainty over the direction of future taxation and regulation as it affects their sector.

But then the government spoilt things by introducing new demands into Merlin's cauldron - including the expectation that banks step up their lending to credit-starved small and medium-sized enterprises. This was followed by the notion, understood to have been introduced by business secretary Vince Cable, that top bankers’ remuneration should be linked to whether their banks meet a state-decreed target of lending £190bn to UK SMEs.

The bankers don’t like this much at all. Last week, I spoke to one senior banker (who is one of the ‘good’ guys). He said that incentivising bankers for lending more to SMEs was madness, and replicated the flawed incentive structures whereby those who lent the most recklessly to British corporates such as HBOS former executive Peter Cummings, trousered the biggest bonuses.

My source remarked that, for the UK government to reward bankers for issuing credit to SMEs at a time when the UK economy and banking sector are in desperate need of deleveraging, is absurd, dangerous and speaks volumes about the economic illiteracy of politicians like chancellor George Osborne and business secretary Cable.

Faisal Islam, the economics editor of Channel 4 News, has also picked up on this theme. In a blog yesterday, he published a quote from a senior banker about the manifest absurdity of Project Merlin.

“We have got ourselves into a bit of a muddle in the UK, because the UK has to deleverage, and there’s absolutely no way that the banks will be able to meet the Basel 3 [Capital] requirements without deleveraging. On one level the UK as a whole has to deleverage, on another the key banks have to deleverage because they don’t have the liquidity and they don’t have the capital, so there’s a sort of Canute-style quality to this debate.”

On February 8, the BBC's business editor Robert Peston reported that the bosses of Lloyds Banking Group, RBS, HSBC and Barclays are “livid”, “furious” and considering “throwing their toys out of the pram” (i.e. scrapping Project Merlin altogether) after the chancellor, Osborne, unexpectedly raised the banking levy by £800m this year.

This will require Britain's large banks (who complain they're being subjected to tougher treatment than banks in any other country of the world) to shell out between £100m and £150m in extra taxes this year - a miniscule sum compared to what they intend to pay out in bonuses.

Whilst Osborne's move has been widely interpreted as a shameless political gesture - given that it was probably timed to deflect attention away from massive tax breaks being offered to banks and other transnational corporations by the UK government (see these articles by George Montbiot and Naked Capitalism's Yves Smith) - it does give the bankers a useful excuse to tear up Merlin, from which Asia-focused bank Standard Chartered has already distanced itself, in disgust.

If the bankers really do abandon Project Merlin they will, for once, have my sympathy. Project Merlin seems to me to be meaningless and shallow PR drivel, a charade designed to give the impression the government is doing something to sort out the UK's dysfunctional banking sector - when in fact it is not doing very much at all.

Even though many remain wards of the state, the UK's bankers are determined to get back to business as usual, even if it entails the same blindness to risk that caused their near demise in October 2008.

It's been widely reported that British bankers intend to award themselves £6bn to £7bn in bonuses for their performance in 2010 - even those working for the nationalized banks such as RBS and Lloyds which would not exist today had they not received government support and recapitalization in 2008 and even though the UK is going through a period of national austerity with pay freezes and large-scale job losses across the public sector.

And last weekend it emerged that the chief executives of HSBC and Barclays, respectively Mike Geoghegan and Bob Diamond are each in line for bonuses of £9m to £10m each. That sure shows some restraint. It is seen as some quarters as the equivalent to putting two fingers up to the government and the British populace.

Serious and carefully thought through structural reform of the banking sector is what’s required. Sadly however this seems unlikely from the relatively lightweight chancellor or the prime minister David Cameron - both of whom have a tendency to buckle as soon as the bankers start jingling their sabres.

I suspect it is much more likely to come from Sir John Vickers’ Independent Commission on Banking - you can read the responses to that here - and from Mervyn King’s Bank of England.

Update 1: February 9th, 2011 8.45pm

The Merlin deal we’ve been waiting for was published earlier today by the UK government — and as expected it is limp-wristed, gimmicky, and designed to give the impression the banks are mending their ways.
Writing in the Guardian, Nils Pratley described it as a comprehensive victory for the bankers. The deal has also been comprehensively rubbished by Lord Oakeshott, the Liberal Democrat treasury spokesman in the House of Lords, who told BBC News:

“If this is robust action on bank bonuses, then my name’s Bob Diamond”.

Oakeshott said: “I’m afraid when you look at the small print, it’s really not as good as it looks,” and that the agreement contained “weasel words”. He also accused the Treasury’s negotiating team of having “an awful combination of arrogance and incompetence”, and they couldn’t “negotiate their way out of a paper bag”. For this intemperance and insolence, Oakeshott was fired on Channel 4 News tonight by first secretary to the Treasury, Danny Alexander (who was being interviewed by Jon Snow). The coalition government may as well have rolled over and allowed the banks to tickle it’s tummy. However, in what seems like wishful thinking, the Financial Times is claiming that Osborne has drawn a line under “banker bashing”.

Update 2: February 9th, 2011 9.15pm

Naked Capitalism’s Richard Smith has written a powerful blog post on the Merlin deal, in which, inter alia, he accuses the Treasury of issuing a “mendacious press release”. Smith also writes: ”One can’t help suspecting that there will next be a determined push to ensure that those other r-words, reform and regulation, get left as far behind as possible” before ending on a more upbeat note. Channel 4 News’s economics editor Faisal Islam has published a more positive blog post based around an interview with Merlin’s wizard-in-chief John Varley.

Update 3: February 10th, 2011 9.30am

Speaking on BBC Radio 4 Today, Lord Oakeshott said the Merlin deal is so riddled with "get out clauses" and "so-called commitments" for the banks that it is essentially meaningless. He said the lending targets outlined in the deal are: "week, waffly, gross-lending aspirations with vast wriggle room." The Daily Telegraph City columnist Jeremy Warner tweeted: "I've now read Merlin and it is just meaningless twaddle that will make no difference to lending. Sorry not to give it fanfare... But Merlin not completely pointless if it puts an end to political point scoring. Don't hold your breath."

Further reading on UK banking and bank bonuses:

Tags: Bank of England , banking , Barclays , central banks , HSBC , Lloyds Banking Group , RBS , UK
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