U.S. banking regulators issue final guidance on incentive compensation

Date: Tuesday, June 22, 2010
Author: Investment Executive

U.S. banking regulators have issued final guidance on how financial firms should be structuring compensation to avoid incentives to take excessive risks, noting that there’s more work to be done by the industry.

The U.S. Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation issued joint guidance on Monday, finalizing guidance that was originally proposed by the Federal Reserve last year.

“The guidance is designed to ensure that incentive compensation arrangements at banking organizations appropriately tie rewards to longer-term performance and do not undermine the safety and soundness of the firm or create undue risks to the financial system,” it says. “Because improperly structured compensation arrangements for both executive and non-executive employees may pose safety and soundness risks, the guidance applies not only to top-level managers, but also to other employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group.”

The regulators report that they have conducted a coordinated examination of compensation practices across firms, and last month the Fed delivered assessments to the firms that included analysis of current compensation practices and areas requiring prompt attention. Firms are submitting plans to the Federal Reserve outlining steps and timelines for addressing outstanding issues to ensure that incentive compensation plans do not encourage excessive risk-taking.

Next, the regulators will be conducting additional reviews of incentive compensation practices at the large, complex banking organizations for employees in certain business lines, such as mortgage originators. The agencies will also be following up on specific areas that were found to be deficient at many firms, such as: identifying which employees can expose banking organizations to material risk; fully capturing the risks involved and applying risk sensitive methods to enough employees; not tailoring deferral arrangements according to the type or duration of risk; and, not adequately evaluating whether established practices are successful in balancing risk.

In addition to the work with the large, complex banking organizations, the agencies are also working to incorporate oversight of incentive compensation arrangements into the regular examination process for smaller firms.

“Many large banking organizations have already implemented some changes in their incentive compensation policies, but more work clearly needs to be done,” said Federal Reserve governor Daniel Tarullo. “The Federal Reserve expects firms to make material progress this year on the matters identified as we work toward the ultimate goal of ensuring that incentive compensation programs are risk appropriate and are supported by strong corporate governance.”