Yesterday, Federal regulators adopted a strategy designed to curb compensation policies of banks that encourage employees to take unnecessary risks. The plan, which was originally proposed last year, has also been endorsed by the Federal Insurance Deposit Corporation, Office of the Comptroller of the Currency and Office of Thrift Supervision.
The undue risk-taking attitude of bank employees supported by their pay policies have significantly contributed to the financial crisis. For the period leading up to the financial chaos, bank employees were often rewarded for increasing the short-term profit of the organizations. However, in that process, the risks that the organizations courted were not properly recognized.
The policy is applicable to around 7,900 banks, both large and small. The move follows a review of the pay practices of around 25 large banks by the Fed. After a six-month review period, the Fed found that a large number of them follow compensation practices that do not adequately restrict employees’ risk-taking behavior.
The Fed also noted that a number of banks are inefficient in identifying employees who expose the entire organization to risk while many banks are deficient in evaluating the success of pay practices in reducing the risk-taking behavior of its employees. Additionally, a number of them are not designing any pay policies to discourage risk takers.
According to the plan, around 25 of the biggest banks, including Citigroup Inc. (C), Bank of America Corp. (BAC) and Wells Fargo & Co. (WFC), are restructuring their pay policies to ensure that the employees are discouraged from taking unnecessary risks.
While the regulators won’t chalk out any compensation package, they will review the pay policies of the organizations and could reject any that encourages risk-taking attitude.
If found suitable, the pay policies would be approved and adopted and the bank supervisors would be entrusted with the responsibility of monitoring compliance. Smaller banks need not provide their plans to the regulators. Instead, reviews will be conducted by the banks’ supervisors.
Regulators in turn are suggesting a compensation practice that is aligned with long-term performance instead of short-time gains, which at times compromise the organization’s security and well being.
For several years, banks have continued to pay handsome compensations to its employees despite the fact that their lending norms and highly speculative attitudes have resulted in the recent financial crisis. This led to a public outcry and in response a pay czar was instituted to restrict compensation and bonus packages of executives at the bailed out companies.
However, the recently-announced plan is applicable to banks irrespective of their participation in the bailout program. The question that now remains is the ability to attract and retain talent following the implementation of such tighter norms by regulators.
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