Large potential severance payments continue to be built into the executive pay packages of directors of the newly nationalized UK banks. If the banking system is to be reformed, we must make make executives truly responsible for the decisions they take.

Bankers used to justify their disproportionately large paychecks and bonuses by arguing that they took on exceptional amounts of risk in their pay. Bankers were paid a large proportion of their income in shares, which reflected the value of the bank. If they did not perform, neither would their companies and neither would their shares. In short, bankers took great risks, and if these paid off, then so were they.

The problem, of course, that has been amply demonstrated by the financial crisis, was that while bankers personally enjoyed the rewards of these risks, they suffered none of the consequences when these risks went wrong. Indeed, if the heads of banks are fired, they have contractually-agreed severance packages that can run into millions of pounds. This encouraged increasingly reckless behavior, as the greatest risk that banking executives as individuals faced was in receiving an obscene severance package, in the place of an obscene pay check.

The most prominent example of this is Fred Goodwin’s pension, supposedly a contractually required payment to a man who presided over the failure of his bank, and approved US$43 billion of investment in the US sub-prime market.

Its a crazy world when a bank is legally obliged to pay over £600,000 a year to a man who effectively bankrupted the company.

But whilst the public debate has focused on bonuses – or limiting the potential gains or the upside that executives receive from taking risk – nothing is being done on the downside. Large severance pay continues to be built into executive contracts, Stephen Hester, the man who took over as chief executive from Fred Goodwin after the bank was nationalised, has a one-year notice period built into his contract.

This means that if the bank wanted to terminate his contract, they would either have to give him a year’s notice or a year’s pay. As no-one ever fires anyone with a year’s notice, this basically means a year’s pay. Mr Hester’s basic salary is £1.2 million a year. On the termination of his contract he would receive this plus any bonus payments he would have received in that year.

Before the first year the bank would have to pay even more, as his initial notice period on signing the contract is two years; that phases down to one year after the first year of service. Compare this to the legal minimum for one week per year of service up to a maximum of 12 weeks.

The top executives from the top UK banks may so graciously have given up their bonuses for last year, but how much of a bonus could they have been realistically expecting with such dismal performance? Real reform however must be targeted at making top executives more responsible for the decisions they make, and this means reforming severance packages as well as bonus structures.

Now I dont want to be accused of writing the second most illiberal article ever written on Lib Dem Voice by suggesting that the Government should legislate to mandate the terms that people can offer in contracts – but the Government should at least exert some influence on the terms offered by banks it owns. In the case of RBS, it is a scandal that the bank is continuing to offer contracts with such large severance agreements.

* George Turner is a Liberal Democrat member, now living in Italy.