Examination of Witness (Question Numbers
12 JANUARY 2010
Q20 Nick Ainger: The answer that
you have given me assumes that you have to give people bonusesnot
reward them properly in terms of their salary but you have to
give them bonuses. Is that what you are saying, that there is
no alternative? You cannot give them a decent working salary and
expect them to perform properly on the basis of that; you have
to give them a bonus?
Mr Hester: Let me put it a different
way. I am sorry if I am frustrating you by answering too long.
Each job that we hireit does not matter what job it isas,
I think, with most walks of life, when you get on to the pay part
of the discussion as opposed to all the other things that go into
a job and why people work, the first point of comparison is what
that person is already being paid wherever it is that they are
working, if you are assuming that you are trying to hire them
from somewhere else, and what it is that would persuade them to
come to you. So the starting point is inevitably what the going
rate is for that job in that context. Now, in some jobs the going
rate does not have a lot of bonus associated with it, and it is
mostly salary, and in other jobs there is more bonus and less
salary, but the principle is always the same: it is what you are
making at the institution we are trying to hire you from, and
we need to be competitive with that in order to persuade someone
to take the risks of moving to RBS. So the specific bonus element
of it will simply vary according to the job and where we are hiring
Q21 Nick Ainger: There were a number
of rumours recently suggesting that the Board of RBS, or a significant
proportion of them, were threatening resignation because the Treasury
were trying to impose restrictions on the bonus payments. Were
those rumours correct?
Mr Hester: As far as I am awareand
I think I would be awareI believe that at no time was there
a threatened resignation of the Boardwere there threats
of any sort, by the way, or a resignation of the Board. I think
where that story came fromand this is speculation on my
partis that we had to publish a very detailed and lawyerised
prospectus for the Asset Protection Scheme and part of the legal
drafting in that prospectus made the point that, as with all boards,
the Board of RBS has a legal duty under companies law to shareholders
and a legal duty under regulation to the FSA to manage the business
both in risk terms safely from an FSA perspective and in the shareholders'
interests, and I think the legal drafting made the point that
there were some aspects of operational freedom that were signed
away by the Board as part of APS to the Treasury that if misused
in the hands of the Treasury could make it hard for the Board
to discharge its legal and regulatory duties. I think out of that
legaleseand there was lots of other legalese in that documentcame
that particular story.
Q22 Nick Ainger: But you can understand
the Treasury and UKFI, with an 84% shareholding, wanting to restrict
bonuses. Can you understand that?
Mr Hester: Yes.
Q23 Nick Ainger: The agreement that
was reached when the Treasury moved in was that RBS would not
pay discretionary cash bonuses in relation to 2009 performance
to any staff earning over £39,000. Does that agreement still
Mr Hester: If I may, there was
an agreement in respect of performance year 2008 and then there
was a fresh agreement that was announced in relation to performance
year 2009 for which bonuses have not been decided yet, but you
are correct in your summary of both those agreements.
Q24 Nick Ainger: My question was,
does that agreement hold? In other words, you will not be paying
any cash bonuses to any staff who are earning in excess of £39,000?
Mr Hester: With maybe a handful
of exceptions of prior legal commitments made in prior years.
Q25 Nick Ainger: Lord Myners has
referred to the profitability of some banks in 2009 as being entirely
fortuitous; in other words, that they can borrow extremely cheaply
from the Bank of England and make a very easy profit by just lending
it out at a reasonable interest rate. I come back to the point
about the justification for bonuses. If substantial profits are
being made by some organisations the easy way, again, how can
you and colleagues in a similar position as you hold still justify
so-called performance-related bonuses in that climate?
Mr Hester: Firstly, you are trying
to paint me into someone who is mounting a rigorous defence of
something which I have yet to utter but I think that what I would
first of all say is to repeat what I said earlier on: it is my
duty as Chief Executive to protect the shareholders' interests
by paying the minimum bonuses that we judge we can get away with
consistent with keeping and motivating good staff. One of the
things we do try to do is go through sources of profit and loss
in attributing merits to people in getting paid and, by the way,
not just look at profit and loss but there is a whole series of
other things that people do in banksrisk management and
so onto which one also attribute things. So it would certainly
be the case that if there were items of windfall profit that we
felt people deserved to be paid either less for or nothing for,
we would want to take that into account in determining pay.
Q26 Nick Ainger: A final question:
the aim of the bank payroll tax according to the Chancellor is
to persuade banks to hold more capital rather than paying it out
in bonuses. The indications so far are that in fact banks will
not be doing that, that they will carry on and they will pay bonuses
and they will pay a substantial amount in bank payroll tax. Do
you agree with the concept of the bank payroll tax to encourage
banks to actually hold more capital rather than paying out bonuses?
Finally, has the introduction of the bank payroll tax affected
the way that RBS are looking at bonuses?
Mr Hester: One of the things that
I think is very important given our state ownership is not to
comment on political measures, so I do not want to comment on
the politics of the bonus tax or otherwise and have nothing to
add to the public debate on that. As it relates to how we are
thinking about its impact on RBS, obviously, I repeat what I said
before: it is our job to try and do the best job for shareholders
and to strike the best line we can between pay, and so as we go
through the process that I have described in the next few months
of seeing what the merits of our own people's case is and what
is the minimum we can get away with in the marketplace, to the
extent that the tax is effective, that will be reflected in RBS's
proposals but inevitably we will be in part prisoner of the marketplace,
and I want to say part because I do believe that within that some
bounds RBS has led the way in a positive sense on reforming pay.
We do have the greatest amount of deferral of anyone in the market,
we do have the greatest amount of clawback, and to this day I
am the only FTSE 100 chief executive with the "no payment
for failure" contract which I insisted on on hiring. These
may be small things, I appreciate, but they are nevertheless things,
I think, in the right direction.
Q27 Chairman: Do you think the system
of bankers' pay bonus in the market is broken?
Mr Hester: I think that the more
important point, which I tried to make earlier on, is that we
have to, on a worldwide basis in the next few years, get to the
point where in a crisis banks do not need the level of public
support that they got.
Q28 Chairman: Would you concede that
in terms of the world bonus payment we are talking about $80 billion,
and in your investment bank the estimates areand I think
you must have a fair estimate of this yourself, Mr Hesteris
that you will pay your investment bankers about £1.5 billion?
Mr Hester: It is a fine line.
If we get to the point, which I sincerely hope we do, and I am
fully in support of the efforts where we can be confident that
banks are not calling on the public purse, and assuming that the
market is competitive and so on, which it is, then I think bankers'
pay becomes a matter for the private sector again but, as I said
at the beginning, we are not at that point, which is why I did
not seek to dispute your opening point.
Q29 Mr Tyrie: Is it correct, as has
been reported in the press, that a number of staff who have come
over from ABN Amro are getting their bonuses earlier than they
would otherwise have done under the terms that they had before?
Mr Hester: No. I think if you
mean the press report in the Telegraph yesterday, it was
inaccurate, and although it was some years ago and obviously not
when I was around, my understanding is that at ABN Amro bonuses
were paid in cash rather than a lot of shares, as they will be
at RBS, and between 50% and 65% was paid in cash up front, and
we have just heard that none will be paid in cash up front and
so on. So actually, RBS is massively more restrictive than any
bank on the planet, including ABN, in its current form of bonus
Q30 Mr Tyrie: So it is not true that
bonuses are being paid over a shorter period than they would otherwise
Mr Hester: That is correct.
Q31 Mr Tyrie: Can I also ask you
about the pool from which these bonuses are being taken? Do you
acknowledge that a large proportion of the money that enables
you to pay bonuses in the beginning is the direct result of government
action or action of the authorities, either because interest rates
are low, making it extremely easy to make a large margin on spreads
for lending or because quantitative easing has boosted asset values
on your balance sheet?
Mr Hester: I think I have a bit
of a yes and a no answer to that. Certainly, taking an extreme,
if there had been no government intervention in the world economic
system a year ago, I think we would have many problems, some of
which would be less profits for banks and some of which would
be other problems for the world economy. If your point was that,
then I agree with your point. I do think that there has been,
on a more narrow basis, an exaggeration of how much low interest
rates help banks. In fact, low interest rates on one level harm
banks by destroying the profitability of deposits, which is why
interest margins of banks have narrowed when they should have
widened. On the other hand, low interest rates help borrowers
and mean that there are less defaults than might otherwise be
the case, which of course helps banks. So there is a whole series
of more complicated swings and roundabouts on the precise economic
intervention but, with the big support for the world economy,
banks have benefited along with everyone else.
Q32 Mr Tyrie: Have your spreads narrowed
Mr Hester: The net interest margin
I believe of all banks but certainly of RBS has narrowed, and
it needs to widen because we are being required to keep more capital.
Within that there has been a shift though, with the profitability
disappearing from deposits and widening on loans and the totality
of the profitability narrowing.
Q33 Mr Tyrie: What about the value
of assets on your balance sheet that have been boosted by QE?
Mr Hester: Quantitative easing
so far has taken the form of the government effectively funding
its deficit by printing money. We have not been taking big gains
on gilts, and so there has not been any direct benefit of QE to
us. To the extent that QE benefits the economy, it does so by
keeping interest rates lower than might otherwise be the case
and, as I have mentioned, interest rates lower than might otherwise
be the case harms us on deposits but helps us on defaults.
Q34 Mr Tyrie: You take issue with
Lord Myners when he says that the bonus pool available to you
is wholly fortuitous and created by government action?
Mr Hester: I am afraid I have
not read his quote.
Q35 Chairman: Following Andrew's
point, how much is earned by what investment banks refer to as
the carry trade, that is, borrowing from the central banks and
then lending it out at interest rates of 6% or 7%? You do not
seem to need to be very clever to make money in that.
Mr Hester: I can only speak for
RBS, of course, but I believe this is a massively exaggerated
topic and in fact, the inverse has been the case in RBS. Because
of the deterioration in the terms on which RBS can borrow, the
ability for us to borrow on the one hand and lend out at a profit
has shrunk, not increased, and that is why our net interest margin
has declined. What I can say is that there is not a substantial
amount of profitability in RBS that is derived from the so-called
Q36 Mr Brady: You have already said
you have shifted your bonus payments towards shares rather than
cash bonuses, but the bank payroll tax applies to bonus payments
in equity or in cash form. Are you concerned that that is giving
the wrong incentive to other banks not to follow moving toward
a longer term equity-based bonus payment?
Mr Hester: As far as I can tell,
but we are still, obviously, waiting for the evidence as other
banks make up their minds, I do not believe that it is causing
other banks to reduce the amount of equity in their bonuses. We
are waiting for the evidence but there does not seem to be that
sign at present.
Q37 Mr Brady: But if you applied
the tax only to cash bonus and not to equity payments, you would
have incentivised a further move in that direction?
Mr Hester: I guess that would
be true, yes.
Q38 Sir Peter Viggers: When you appeared
before us last February you gave the time frame of returning RBS
to the private sector as three to five years. Is that still the
Mr Hester: The restructuring story
of RBS, as I described it before, is the biggest and most complex
bank or company restructuring in history. I am sorry to say I
wish it were not but it is. So far I have been incredibly pleased
by how well it has gone, which is, of course, in large part due
to the support of lots of people, and we are, if anything, well
ahead of where I thought we would be and did not slip on as many
banana skins as I thought we might last year. That gives me encouragement
to believe that we can hit all of the ambitious targets that we
put out for the recovery of RBS in terms of its safety, in terms
of its service to customers and in terms of restoring shareholder
value. It is only if we restore shareholder valuecrudely,
getting the share price up and creating conditions where investors
want to buy our sharesthat the conditions for privatisation
successfully exist, ie that the government can sell its shares
to willing investors at a profit. I believe we are on track for
that. I would be hopeful that there would be a number of opportunities
for share sales to be made at a profit over the next three or
four years. Of course, the decision on whether to sell and when
will always be that of the shareholder, in this case the government.
Q39 Sir Peter Viggers: I was going
to ask if you feel pressure from the Treasury or from UKFI compared
with the situation you would be in if you were a purely private
sector chief executive.
Mr Hester: I have to say candidly
to you that my experience of UKFI over the last year has been
very positive. I believe that they have behaved exactly as their
charter sets out. They have been a very engaged, commercially
oriented shareholder, ensuring that if they believe in, and if
they do, then support our actions to support the bank. Our dialogue
with them in most instances has been a more detailed version of
the dialogue we would have with other major shareholders. There
are, of course, some aspects of politics that leak into the relationship,
as you would expect, but the dominant part of the relationship
is really the shared goal that I believe we have with the rest
of the UK, which is that if RBS successfully recovers, the taxpayer
will get his and her money back, and in that we have an absolutely
fundamental alignment of interest.