Investment bank bonus structures are an operational risk

This is one of the interesting topics that came up for debate at a risk event I attended yesterday organised by the CASS Business School in London and the Capco Institute.

The recent sub-prime and liquidity crisis has prompted many commentators to look at the role of investment banking remuneration and management structures in building what Fortune magazine and others have referred to as 'the Tinkerbell economy' (which was only viable as long as everyone continued to believe in it and make money from it). 

Robert Preston's BBC programme The Greed Game (and his blog post on the programme) sums this view up nicely and has generated lots of debate.

At yesterday's conference, it was pointed out that 90-95% of bonus pools at investment banks go to those senior people in the organisation who operate by assuming credit and market risk, which obviously generates healthy returns when things are going well, but also spectacular losses and global economic damage when their views of risk are skewed and things go wrong.

As a result, asked a member of the audience, isn't it difficult for the senior managers in charge of operational risk to get their views taken seriously and be involved in strategic decisions (as many suggest is an increasing need/trend)? This is particularly the case as the rewards when operational risk is managed effectively aren't always immediately apparent to those with an eye solely on quarterly profits.

Hans Geiger of the Swiss Banking Institute pointed out that the mechanisms of bonus schemes, if they are viewed as creating failures in people and processes that contribute to losses, could be seen as an operational risk. Therefore they could potentially be subject to regulatory scrutiny.

In fact, he said the Swiss Central Bank had recently made statements about investment banking bonus structures, the first time he is aware that a central body had done so.

If this is an idea that gains momentum (which I doubt, by the way), you can expect a lot of lobbying against it from those in the industry who benefit, or hope to, from the current reward structures.