Bankers and their bonuses

Are banks still paying bonuses?

Yes. In the year to last April, a period encompassing the nationalisation of Northern Rock, the collapse of Bear Stearns and multi-billion losses on subprime-linked investments, they paid out £8.5bn, much the same as during the boom year of 2006-07. Payouts will fall this year, but London bankers still expect to scoop £3.6bn. Yet that figure is dwarfed by the payouts on Wall Street, where bonuses in the six largest banks are forecast to top $70bn – a tenth of the US government's $700bn bank bailout. Almost all the $25bn that Citigroup is to receive in state capital will be spent on salaries and bonuses. Lehman Brothers finalised a $6.12bn pay plan just days before it succumbed to bankruptcy.

How important are these bonuses to bankers?

Very. They account for at least 60 per cent of their pay. A divisional managing director at an investment bank, on a basic salary of £150,000, would expect an annual bonus of at least £1m; "rainmakers" (traders who drive a bank's profits in lucrative new markets) would expect far more, with bonuses calculated as a generous percentage of the cash they bring in. The rule of thumb at most banks is to channel 45 to 50 per cent of net revenue into salary and "discretionary bonuses". The exact sums are often clouded in secrecy: though directors of publicly quoted banks must disclose earnings, they don't have to reveal what they pay star traders. The biggest disclosed bonus in the City last year was paid to Barclays' investment banking chief, Bob Diamond, whose £21m package dwarfed the £3m earned by its chief executive, John Varley.

And what are the alleged dangers of this bonus culture?

Some claim that bankers spend so much time politicking over bonuses that business at investment banks virtually grinds to a halt towards the end of each year. Others say that the huge City payouts inflated the top end of the housing market, while contributing to a socially corrosive widening of inequality. But the biggest charge against bonuses is that, by encouraging bankers to take huge risks, they were a key factor in destabilising financial institutions and may even have precipitated the current crisis.

Why does the system fuel extravagant risk-taking?

Because it handsomely rewards strategies that focus on short-term profit-making, with no regard to long-term consequences. If traders pocketing mega-bonuses lost billions a few years later, tough luck: the bonuses were paid and consumed long before they could be held accountable. And banks rarely, if ever, took steps to claw them back. For the individual trader, the potential downside of engaging in excessive risk is thus far outweighed by the potential upside. In this perverse heads-I-win-tails-you-lose scenario, it was left to shareholders and, ultimately, taxpayers to shoulder the losses. The traditional capitalist balance between personal and corporate risk had been blown away completely.

How did this system come about?

Some date it to the early 1970s when a mass of Wall Street banks transformed their legal status from partnerships to corporations and then floated on the market. Until then, a