The Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the FDIC issued final guidance to ensure that incentive compensation arrangements at financial organizations take risk into account and are consistent with safe and sound practices.
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. Because improperly structured compensation arrangements for both executive and nonexecutive 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 guidance is effective upon publication in the Federal Register, which is expected shortly.
The Federal Reserve, in cooperation with the other regulators, has completed a first round of in-depth analysis of incentive compensation practices at large, complex banking organizations as part of a so-called horizontal review, a coordinated examination of practices across multiple firms. During the next stage, the banking agencies said they will conduct additional cross-firm, horizontal 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 follow up on specific areas that were found to be deficient at many firms, such as:
- Many firms need better ways to identify which employees, either individually or as a group, can expose banking organizations to material risk;
- While many firms are using or are considering various methods to make incentive compensation more risk sensitive, many are not fully capturing the risks involved and are not applying such methods to enough employees;
- Many firms are using deferral arrangements to adjust for risk, but they are taking a “one-size-fits-all” approach and are not tailoring these deferral arrangements according to the type or duration of risk; and
- Many firms do not have adequate mechanisms to evaluate whether established practices are successful in balancing risk.
Federal Reserve staff will prepare a report, in consultation with the other federal banking agencies, after the end of 2010 on trends and developments in compensation practices at banking organizations.
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