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Fed plan would police banks' pay for 1st time

September 19, 2009|Neil Irwin | Irwin writes for the Washington Post.

WASHINGTON — The Federal Reserve is moving to restrict compensation practices at the nation's large banks, aiming to rein in pay arrangements that threaten to distort incentives for everyone from chief executives to loan officers.

The Fed, in its role as the lead regulator of the biggest U.S. banks, is looking to monitor pay practices at those institutions as part of its responsibility for ensuring their safety and soundness, sources familiar with the plans said. It aims not to set caps on the amount of pay any given employee can receive, but to restrict banks from paying employees in ways that create long-term risks to the institution.

Private analysts and Fed officials argue that pay practices emphasizing short-term performance contributed to the excessive risks that large banks took during the run-up to the financial crisis.

For example, a trader who receives bonuses based solely on short-term performance may take irresponsible long-term risks, and a loan officer paid solely based on the volume of loans issued might not pay enough attention to the quality of those loans. Under the approach envisioned by the Fed, banks would have to explain these pay practices to their regulator and adjust them if examiners believe they create excessive risk.

The Fed Board of Governors is slated to approve proposed guidance on the new regulatory approach in the coming weeks, after which there would be a comment period, followed by final approval. But bank regulators are already gathering information about pay practices from the institutions they oversee.

"Bonuses and other compensation arrangements should not provide incentives for employees at any level to behave in ways that imprudently increase risks to the institution, and potentially to the financial system as a whole," Fed Gov. Daniel Tarullo said in congressional testimony last month. He added that the Fed expects to issue its guidance on compensation soon.

The Fed's efforts are distinct from other efforts across the government to rein in compensation at financial companies. The Treasury Department is weighing how to restrict pay at firms that have received federal bailout money. And Congress is weighing legislation that would curtail pay to executives.

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