EU plan to cap bank bonuses could backfire When the chief executive of Deutsche Bank calls the south-east of England's member of the European Parliament for a chat, it is probably a sign of jitters. In picking up the phone to Sharon Bowles recently, Anshu Jain was reflecting a widespread fear in the sector - that the European Parliament's plan to cap bankers" bonuses at the level of their base salary will make the continent's banks uncompetitive. The legal process, though, is starting to look unstoppable, no matter how high-ranking the lobbyists. The MEPs" beef is an obvious one - echoing the gripes of many of their constituents they hold bankers responsible for the financial crisis and believe they are overpaid. Bankers have, of course, always been well rewarded - not only chief executives, but also top traders and advisory specialists within investment banking divisions. What rankles now, after so many banks have been bailed out by governments, is that pay seems more generous than ever. Shareholders have been roused into protest by a similar sense of being cheated, staging rebellions against the likes of Citigroup, Barclays and Credit Suisse. After stomaching precipitous falls in share prices over the past five years, investors feel the share of spoils they are receiving compared with the amounts going to staff is too low. As the Financial Times reported early this month, the average proportion of profits plus pay distributed in dividends has slumped by two-thirds over the past five years, while the proportion allocated to pay has jumped by nearly half. And while traders" pay is not normally disclosed, there are plenty of easy targets among chief executives. Bob Diamond is the most routinely cited. Last year the Barclays chief executive received a salary of £1.35m but total pay of £25m, despite shrinking profits, a falling share price and a tiny dividend. In Spain, Rodrigo Rato, the former head of the IMF who led Bankia until the lender's nationalisation last month, enjoyed a €2.3m package of salary and bonuses last year even as the group was sinking into crisis. Spain, like Germany, has now tried to head off populist anger by capping pay. In February it set a €600,000 limit on total executive remuneration for any bank that had taken state aid. Now the European Parliament is going far further with its plan to impose a 1:1 ratio on pay and bonuses across all EU-based banks and their senior bankers, dubbed "code staff" in the jargon. There are several reasons why it is specifically seeking to limit bonuses. The first is political - bonuses are often big numbers seized on by the media and electorates. The second is economic - as Sony Kapoor, managing director of European think-tank ReDefine, argues, by paying people in the form of bonuses, you are motivating excessive risk-taking. But here's the snag. However resentful you are of bankers" pay levels and whatever the justifications for wanting to curb them, there is a real danger that heavy-handed rule-making is either dodged by clever arbitrageurs or else backfires to everyone's detriment. Look at the last piece of European rule-making, when it was decided that senior bankers would have to have the bulk of bonuses deferred over several years and paid in shares, rather than cash. This is a fine idea on paper, but the banks responded by raising basic pay to offset the lost bonus. Bankers say the same will simply happen again now. If they are right, the European rule changes could restrict banks" ability to keep costs flexible. Instead of cutting bonuses in cyclical downturns, they will have to go through the disruptive and expensive process of cutting more jobs. The other outcome could be worse still. If banks simply apply the European cap, it will distort the market in several undesirable ways. Non-European banks will shift global business heads away from the region to escape the rules. European banks will have another reason to consider shifting headquarters outside the EU. And all the while, there would be a dreadful disincentive for anyone to be promoted into the "code staff" category - typically the top 100-200 employees in a bank. The perversity of this is obvious. By demotivating advancement, you are incentivising second-rate people to run high-risk institutions - the perfect recipe for another crisis. Going after bankers" bonuses is the wrong target. Overall pay is the issue and shareholders should step up the drive they have already begun to be the instruments of change. Patrick Jenkins is the Financial Times's Banking Editor