Plan Calls For Fed To Check How Banks Reward Risk

In an unprecedented move, the Federal Reserve is working on a plan to prevent a repeat of the financial crisis by scrutinizing banks’ pay policies to ensure they don’t encourage taking risks that threaten the entire economy as well as the stability of the institutions.

According to a plan not yet made public, the Fed would check salaries, bonuses and other compensation of CEOs, other top managers, traders, loan officers and any others who take risks on behalf of the banks. In addition to looking at compensation levels, policies such as when employees are rewarded would be subject to policing.

About two dozen banks considered to be the largest would get the closest scrutiny through comparisons of their practices and those of rivals. This would mean some compensation structures would have to be modified although the ability to customize pay packages to best suit the banks’ needs would remain. The Fed would not set any of those packages.

The rules would target all firms regulated by the Fed. That includes more than 5,000 bank holding companies and more than 800 smaller state-chartered banks. It’s expected that smaller banks’ plans would be evaluated during regular evaluations.

The subject of compensation is expected to come up this week when President Barack Obama meets with his counterparts from other major industrialized countries at the Group of 20 summit in Pittsburgh. French President Nicolas Sarkozy is spearheading a European effort to regulate bonuses paid to bankers.

Under the guidelines in the proposal, there is no one particular method of capping pay at a certain level. Instead, the rule of thumb will be for banks to provide more in-depth plans on how they will reach profits. That reduces the potential of taking high risk just to reach short-term rewards. Fed officials also are considering the potential of getting compensation back when later it is discovered excessive risks were taken to reach goals.

Pay also could be deferred. In one scenario, restricted bank shares that take longer to vest could be used. This would allow bank officials to take the time needed to weigh whether revenues that resulted from a particular action were worth the risk.

The proposal carries its own risks. Congressmen and others may complain that the Fed is exceeding its authority and should be restrained.

The Fed’s Board of Governors has not voted on the plan, whose details could be officially proposed in a few weeks. Work on the proposal started earlier this year.

Members of the banking industry and the public will be allowed to comment on the plan, which could then be revised. The Fed is expected to begin the review process for larger banks as soon as the plan is released. The Fed board could adopt a final version of the plan as soon as the end of the year.