Federal regulators on Monday adopted a plan to ensure that banks' pay policies don't encourage employees to take reckless gambles like those that contributed to the recent financial crisis.
The plan, originally proposed by the Federal Reserve last year, was also endorsed by other key banking regulators — the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
Many banks' practices have been found deficient in curbing risk-taking based on an in-depth analysis by regulators, the Fed said. It has directed banks — which weren't identified — to take steps to fix their policies.
"Many large banking organizations have already implemented some changes in their incentive compensation policies, but more work clearly needs to be done," said Fed Governor Daniel Tarullo, the central bank's point person on the matter.
The regulators won't actually set compensation. Instead, they would review — and could veto — pay policies that could cause too much risk-taking by executives, traders or loan officers.
As part of that process, the regulators will be conducting additional reviews of banks' compensation practices and making sure that they follow up on deficiencies.
Many banks need better ways to identify which employees can expose the entire institution to risk, the Fed said. Many banks' policies aren't fully capturing the risks involved and not applying risk-curbing measures to enough employees. Many banks also don't have sufficient ways to evaluate whether their compensation practices are successful in curbing risks. And, many are not tailoring their practices to discourage risks, the Fed said.
All told, nearly 8,000 banks would be covered by the plan.
In the heady days leading up to the 2007-2009 financial crisis, banks too often rewarded employees for increasing the firm's short-term revenue or profit, without adequate recognition of the risks posed for the company.
The regulators, among other things, suggest that banks carefully review "golden parachutes," which typically provide senior executives with large payments without regard to outcomes, to ensure they don't encourage undue risk-taking.
Under the plan, the 28 biggest banks — including Citigroup, Bank of America and Wells Fargo & Co. — are developing their own plans to make sure compensation doesn't spur undue risk taking. If the regulators approve, those plan would be adopted and bank supervisors would monitor compliance.
At smaller banks — where compensation is typically smaller — banking supervisors will conduct reviews. Those banks don't have to submit plans to regulators.