Negotiations between the European Parliament and the Council ended late on June 29th  with a deal for new rules on capital requirements for banks and a cap on bonuses for bankers. This new EU wide law, the first cap on how bankers are paid worldwide, will transform the bonus culture and end incentives for excessive risk taking.

Together these new rules will lay the foundations for a safe and sound capital base and a responsible pay and bonus policy, so that taxpayers don't face the risk of bailing out the banks once again. Banker's salaries and bonuses and the control over financial sector was an issue the European Parliament backed at its first plenary session after the Pittsburgh G-20 Summit, back in September 2009.

Now, after the agreement reached between Parliament and Council, cash bonuses will be capped at 30% of the total bonus and to 20% for particularly large bonuses.  In place of upfront cash a large part of any bonus must be deferred and can be recovered if investments do not perform as expected.  Moreover At least 50% of all income not deferred would be paid as "contingent capital" (funds to be called upon first in case of bank difficulties).

Bonuses will also have to be capped to salary.  Each bank will have to establish limits on bonuses related to salaries, on the basis of EU wide guidelines, to help bring down the overall, disproportionate, role played by bonuses in the financial sector.

Finally, bonus-like pensions will also be covered.  Exceptional pension payments must be held back in instruments such as contingent capital that link their final value to the underlying strength of the bank. This will avoid similar situations experienced recently of bankers walking away from disaster with an enormous cash pension pot.

To address moral hazard the law will introduce special measures for bailed out banks and it will restrain the overall amounts paid in bonuses, encouraging bankers to prioritise a stronger capital base and lending to the real economy over their own pay and perks. The rules will also require that the repayment of taxpayers is the priority. These rules follow the evaluation criteria on the return to viability and assessment of restructuring measures in the financial sector that the Commission already published on August 2009.

Capital requirements for stable banks

New capital rules for re-securitisations and the trading book will ensure banks are properly covering the risks they are running on their trading activity, including for types of investments like mortgage backed securities that were central to the crisis.

Following Wednesday's official agreement from Council, the text will now be submitted to the Parliament's plenary for approval.  Once this is finalised the rules are expected to take effect in January 2011 for the bonus provisions and January 2012 for the capital requirements provisions.