Banks must stop targeting return on equity as a measure of their success to avoid excessive risk-taking and harm to long-term shareholders, a member of the Bank of England's interim Financial Policy Committee said in an opinion piece for Reuters on Monday.
Targeting RoE (return on equity) has contributed to volatility of returns, excessive leverage, reckless risk-taking and systemic instability, Robert Jenkins wrote.
It has not contributed to the creation of sustained or sustainable shareholder value, the external FPC member said. As a key motivator for bank behaviour, it has to go.
Jenkins' comments chime with those of fellow FPC member and Bank executive director Andrew Haldane, who said last week the focus on RoE had lead to a situation where high returns were harvested by banks' management and shareholders while the risks had been borne by wider society.
The FPC was set up by the government as part of sweeping reforms to strengthen regulation and prevent a repeat of the financial crisis. So far, it only has a vague remit to identify and minimise systemic risks.
Excessive risk-taking has been one of the reasons blamed for the financial crisis and the collapse of banks such as Lehman Brothers.
Large pay packages in the banking industry have also fuelled public anger and lead to protests such as the Occupy Wall Street movement -- which has spawned a similar sit-in protest in the heart of London -- at a time when many countries are having to cut spending because of soaring debt caused by the crisis and the hundreds of billions spent on bank bailouts.
Jenkins said the focus on return on equity has effectively been a bad deal for many investors. For the longer term investor, many bank share investments have proved the equivalent of capital contributions to not-for-profit companies employing exceedingly well paid staff, he said.
Jenkins said that in many banks, executive pay was attached to earnings per share or return on equity targets. These prompt them to maximize non-risk adjusted returns (R) and minimize confidence building capital (E), he said.
It is time for shareholders to insist on a proper alignment of bank pay practices with the interests of their owners, he said.
Jenkins suggested that a focus on return on assets (RoA) or return on risk-weighted assets could provide better results.
The Group of 20 leading economies, whose leaders meet this week to rubber-stamp key steps to make the financial system more stable, agreed in 2009 to bring in new regulation and tighter scrutiny of bankers' pay to ensure that financiers were not rewarded for excessive risk taking.
Countries agreed to force banks to ensure bonuses were not simply based on how much profit or revenue an employee generated but should also be negatively linked to the degree of risk taken.
Global regulator the Financial Stability Board said earlier this month that many banks had made good progress in adopting tighter rules on bonuses but said some countries were still lagging behind.
It also rebuffed banks' complaints that some of their rivals were bending these new rules in order to poach staff.
(Reporting by Sven Egenter, editing by Mike Peacock)