Margareta Pagano: New Beowulf takesa swipe at the City'sover-paid dragons

Mervyn King, the Governor of the Bank of England, is in danger of becoming a hero, a Beowulf for our times.

King hasn't slain the dragon yet but there are clear signs that his Special Liquidity Scheme is beginning to work as banks have now started to swap their illiquid mortgage securities and corporate loans for new bonds. While the Bank won't say how the rescue operation is going, bankers confirmed last week they are taking up the offer. While more than the £50bn tranche will be needed, there is growing recognition that King has pulled off a blinder.

But it was King's comments to the Treasury Select Committee last week which make him the real hero. He was absolutely right to lambaste the way the City rewards itself, and point out how the compensation system encourages bankers to take risks because of the structure of their bonuses. Angela Knight, who runs the British Bankers Association, was wrong to leap to the City's defence so quickly and misguided to suggest the issues shouldn't be aired publicly.

Quite the reverse; this is a debate too important to be kept behind closed doors. King's thoughts on how pay is structured have all the more resonance because they were made by someone of his stature; they are neither the politics of envy nor the view of a dirigiste. What King is saying is that the way the City structures its pay is pernicious for its long-term health. He's right.

To recap, King made two points. First, he argued that the promise of huge bonuses distorts how bankers go about their business; they take risks at shareholders expense with no liability to their personal bottom-line. The second was that too many of the UK's talented youth are enticed into the City because they are paid so much more. Who can blame them?

King is right about the distortion and many bankers are now agreeing with him. UBS accepts that the way it paid traders led them to take risks they would otherwise not have taken while some of the industry's top bankers, such as Deutsche's Josef Ackermann, are looking at how to change the structure. But this is like watching Groundhog Day, again. It's what bankers say at every downturn. They get very introspective, admit their greed and slink out of view. Incentives get redesigned, bonuses go down and jobs are lost. But in a few years time the carousel will start all over again.

It's not rocket science to find a fairer system: you pay smaller bonuses, get rid of most performance related schemes and encourage staff to buy shares at the market price rather than through options. But non-executives have a big role to play – on all boards as well as the banks. It's not just the traders who take risks with shareholders money – without any liability to themselves – but the corporate financiers too.

Take the position of Merrill Lynch which advised Royal Bank of Scotland on the ABN Amro bid, a move which has destroyed billions in shareholder value and forced it to launch a rights issue of £12bn. Merrill not only picks up millions for the corporate advice but also gets the fees for underwriting the cash-call; but there is no loss to its bankers for lousy advice. Merrill is not the only guilty party; all the big US banks work like this.

King's second point about graduates is more complex. If graduates are offered salaries of £35,000 at an investment bank or £20,000 with an engineering company they will be tempted by the former. If a trader makes £10m, he gets 10 per cent or £1m. But, if you are a young engineer who helps design the next aerospace engines, you get about £40,000 a year. Even though that engine may revolutionise air transport – and in the process make the company millions – the worker won't share in the proceeds.

How do we encourage the young into industry? Only a few decades ago the brightest did go into industry and even government. When Nomura, the Japanese broker, hired more Oxbridge candidates than the Foreign Office in 1985, it made front page news. I don't think industry would find it hard to lure graduates away from accountancy or trading at all – most are only there for the money, which is tragic. Industry bosses argue that they can't match City salaries. There are alternatives, such as wider share ownership or aligning salaries to profit.

Government can help on a broader level by making it easier to start up businesses – the UK now has the lowest rate in Europe for new start-ups. Sadly, ministers will need collective brain surgery before they understand just how important creating an easier mood in which business can flourish is to our social well-being.

King also made a point of saying how much he admired small business entrepreneurs, a gentle snub to City chaps. His quiet, donnish manner plays well to the press gallery in Parliament and, with his second term now under way, let's hope he continues to go where others fail to tread.

It's a delicious irony, but King will still be on his throne when this Government has gone.

BETTER SAFE THAN SORRY FOR HBOS – BUT TELL THAT TO THE SHAREHOLDERS

One in five people in the UK rely on Andy Hornby, chief executive of HBOS, for the security of their mortgages, and one in three for their savings. They will be relieved he finally bit the bullet last week when the UK's biggest mortgage lender decided to go ahead with a £4bn rights issue. They can sleep easier at night.

But shareholders may need some Nytol. Many reckon Hornby has raised too much money, which will be too diluting. Analysts, too, have attacked the bank for "excessive prudence". Others, though, have said it hasn't raised enough.

It wasn't a pain-free option for Hornby. His chairman, Lord Stevenson, and the board agonised for days but were persuaded that it was far better to be prudent, to take more writedowns on their trading book, rather than muddle through. Hornby reckons it's the best strategy, defensively and offensively: the new capital gives HBOS one of the strongest core equity tier-one ratios in Europe, allowing it to withstand choppy times ahead.

HBOS says it's pretty grim out there in the real world. It should know – it owns an estate agency, Crest Nicholson, and has a big exposure to the retail sector as a lender to Arcadia.

House prices have now fallen for the third month running and HBOS predicts they will fall by 5 per cent over the year. The wholesale lending markets are still closed and the bank doesn't see them opening up again properly for another year.

Investors, who have been tapped now for new money by both RBS and HBOS, are on the edge waiting to know if there will be more calls from Barclays, and possibly Lloyds TSB this week. They can't see how Barclays can avoid it and want to know why Paul Idzik, the chief operating officer, is leaving. Barclays will be forced to give more details on 15 May in its interim trading statement. It may well raise new money from its sovereign wealth investors but other shareholders won't like that because it's against pre-emption right principles. They may need more than a sleeping drug.