Fed unveils rules to curb 'risk taking' incentive pay
2009-10-22

People Ben Bernanke Barack Obama Event Global Financial Crisis Category US Fed Reserve Source (AFP)

WASHINGTON (AFP) - The Federal Reserve unveiled rules Thursday to curb incentive compensation at banks that encourages "excessive risk-taking" and undermines the stability of the financial system.

The proposed rules, still in provisional form and subject to comment for 30 days, are part of an effort to toughen supervision to avoid a recurrence of the near-meltdown of the financial system last year.

"Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability," Federal Reserve chairman Ben Bernanke said in a statement.

"The Federal Reserve is working to ensure that compensation packages appropriately tie rewards to longer-term performance and do not create undue risk for the firm or the financial system."

The proposed rules stop short of specific pay caps or dollar targets for bonuses or commissions, but instead offer guidance for compliance with the rules.

But they noted that "where appropriate, the Federal Reserve will take supervisory or enforcement action to ensure that material deficiencies that pose a threat to the safety and soundness of the organization are promptly addressed."

The plan calls for special rules applying to 28 "large, complex banking organizations."

"These firm-specific policies will be assessed by supervisors in a special 'horizontal review,' a coordinated examination of practices at the 28 firms," the Fed said.

Additionally, Fed officials "will review compensation practices at regional, community, and other banking organizations not classified as large and complex as part of the regular, risk-focused examination process."

"These reviews will be tailored to take account of the size, complexity, and other characteristics of the banking organization," the statement said.

The proposed rules state that incentive compensation arrangements "should not only be balanced in design, they also should be implemented so that actual payments vary based on risks or risk outcomes."

For senior executives at major banks, the rules say that incentive pay arrangements "are likely to be better balanced if they involve deferral of a substantial portion of the executives' incentive compensation over a multi-year period."

This could reduces pay in the event of poor performance over a longer time span, the rules indicate.

The arrangements are better balanced "if a significant portion of the incentive compensation of these executives is paid in the form of equity-based instruments that vest over multiple years."

The rules suggest the Fed may be tough on so-called "golden parachutes" that allow executives to walk away with hefty pay regardless of the company's fortunes.

These arrangements "can provide the employee significant incentives to engage in undue risk-taking," the Fed said.

The Fed said it would await further comments before deciding on some elements of the rules.

"Some have suggested that one or more formulaic limits be adopted for some or all banking organizations," including one possible formula in which at least 60 percent of all incentive compensation received by senior executives of major banks be deferred and at least 50 percent in the form of stocks or options.

Following the financial crisis, President Barack Obama had appointed a special master for compensation given the task to more closely tie pay packages to long-term performance.

This was aimed at helping prevent employees from taking unnecessary risks for short-term gains as the administration believed skewed compensation incentives were one cause of the crisis that plunged the country into prolonged recession.