Royal Bank of Scotland, Northern Rock and Lloyds Banking Group - Treasury Contents

Examination of Witness (Question Numbers 20-39)


12 JANUARY 2010

  Q20  Nick Ainger: The answer that you have given me assumes that you have to give people bonuses—not 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 hire—it does not matter what job it is—as, 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 people from.

  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 aware—and I think I would be aware—I believe that at no time was there a threatened resignation of the Board—were there threats of any sort, by the way, or a resignation of the Board. I think where that story came from—and this is speculation on my part—is 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 legalese—and there was lots of other legalese in that document—came 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 hold?

  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 banks—risk management and so on—to 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 are—and I think you must have a fair estimate of this yourself, Mr Hester—is 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 deferral.

  Q30  Mr Tyrie: So it is not true that bonuses are being paid over a shorter period than they would otherwise have been?

  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 or widened?

  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 carry trade.

  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 time frame?

  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 value—crudely, getting the share price up and creating conditions where investors want to buy our shares—that 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.

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