Andrew G Haldane: Financial arms races Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at the Institute for New Economic Thinking, Berlin, 14 April 2012. All speeches are available online at www.bankofengland.co.uk/publications/speeches  *  *  *  Elephant seals have got too big for their beaches. A large specimen might weigh over 8000 lbs (3700 kg).1 Their size has a simple evolutionary explanation. Large males fight for the right to mate with a whole beach full of females. For elephant seals it is, quite literally, winner-takes-all. And the key to winning is simple – size. No-one is going to argue with a male swinging around his proboscis on the beach. In that way, size has become the dominant gene in the evolutionary trajectory of the elephant seal. But size is not costless for the elephant seal. It makes them easy prey on land. At times in the past, this has threatened their very existence. In the 18th century, their main land predator – man – hunted elephant seals for their blubber and fur. In the 19th century, their numbers fell rapidly to below 100 and for a time they were believed to be extinct.2 Just in time, governments intervened to place restrictions on hunting, nationally and internationally. Today, elephant seal numbers have swelled to above 800,000. The hand of government has protected them from man – and from themselves.
This duration mismatch means it is more likely than not that risk and reward may get out of kilter in the financial sector. The current environment is evidence of such a mismatch: while bank performance has fallen off a cliff, executive pay remains close to pre-crisis Himalayan heights. Lengthening deferral or claw-back periods, say to 10 years or more on an internationally co-ordinated basis, would help close this gap in horizons, between risk and return. It would elongate the period of liability bank managers face when they take on risk. This would better align firm-level risk-taking incentives with the societal optimum. Avoiding relative benchmarks in the setting of remuneration would also reduce the risk of an upwards-only pay escalator. 29  Bank of England (2012). 30  Bank of England (2011b). 31  Bebchuk and Fried (2003). 8  BIS central bankers’ speeches  There is scope, too, for a reconsideration of the instruments used for remuneration. The focus to date has been on non-cash distributions, often in equity. But paying in equity appears in some pre-crisis cases to have exacerbated risk-taking incentives, acting as a disincentive to raising new equity and encouraging gambles for resurrection. Remunerating in long-maturity debt, or contingent capital instruments, may do a better job of aligning risk-taking incentives with the public good than either cash or equity.32 Speed races in financial markets potentially generate societal sub-optimality, for example due to message traffic congestion.