Editor's Take: Bonuses as a % of returns on capital are bad news for bankers

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UBS' plan to link bankers' payouts to returns on capital is likely to hammer bonuses lower than ever. Even worse, it may well catch on.

UBS announced the new bonus arrangements today, along with its quarterly results. In the words of the Financial Times, 'compensation in the three distinct operations of equities, investment banking and fixed income, currencies and commodities (FICC) will be measured by each individual operation's return on capital.'

We spoke to one of the architects of the new pay arrangements, who says they're a new thing - not only for UBS but for any big investment bank.

However you look at it, bonus prospects at UBS aren't good. But using returns on capital instead of revenues or profits to determine future payouts will probably ensure they stay bad for a long time.

According to UBS's latest quarterly results , net income as a percentage of average attributed shareholders' equity in its investment bank was -7% in Q2. CreditSights analyst Simon Adamson, says historical returns were more like 15%.

If return on capital formulae are used to calculate bonuses industry-wide, the outcome will almost certainly be structurally lower bonuses for everyone.

According to Adamson, some investment banks achieved 25-30% returns in the years preceding the crunch.

However, most banks are now moving to raise more capital, and regulators may yet call for still more stringent capital requirements. Even if profits eventually recover, therefore, returns on capital will not.

And if bonuses are allied to returns on capital, they will suffer the same fate.