Regulators Talk Risk-Based Compensation

The Federal Deposit Insurance Corp.'s (FDIC) board of directors has approved an Advance Notice of Proposed Rulemaking (ANPR) seeking input on whether certain employee compensation structures pose risks that should be captured in the deposit insurance assessment program.

‘A broad consensus of academic studies agrees that poorly designed compensation structures can misalign incentives and induce risk taking,’ says FDIC Chairperson Sheila Bair. ‘I share those concerns. The recent crisis has shown that compensation practices that encourage excessive risk can create significant losses in the financial system and the deposit insurance fund.’

The ANPR includes a broad set of questions designed to solicit information on the types of structures that should be encouraged and on whether and how employee compensation should be factored into the risk-based pricing system, the FDIC says. The ANPR will go out for public comment for 30 days after publication in the Federal Register.

‘I believe this ANPR suggests a good approach by targeting compensation structures, rather than levels of compensation," Bair adds. "It contains no features which would limit the amount of compensation paid to employees."

U.S. Comptroller of the Currency John C. Dugan, however, finds fault with the FDIC's approach. Saying issuance of the ANPR would be premature, Dugan notes the financial regulatory bill passed by the House of Representatives in December 2009 requires disclosure of incentive-based compensation to regulators and prohibits certain compensation structures. In debating its version of the bill, the Senate will likely address the topic in a similar fashion. Moreover, the Federal Reserve is developing guidance pertaining to risk-based compensation.

"It would be very unfortunate to have an end result where insured institutions – and perhaps their holding companies – were subject to inconsistent schemes evaluating the risk of their executive compensation programs," Dugan says.

Dugan also suggests the ANPR goes beyond the FDIC's responsibility of preserving the Deposit Insurance Fund.

The FDIC's approach would "apply to a much broader array of compensation arrangement – for banks large and small – for which there is no empirical connection to losses sustained by the Deposit Insurance Fund," he said.

More bank fees are expected to be discussed Thursday when President Obama will announce a TARP fee targeting large banks, Reuters reports. Citing an anonymous administration official, Reuters says the fee will help to raise as much as $120 billion, which would be used to cover losses stemming from last year's bailout program. Reuters' source said numerous structures for the fee are being considered, including one that would be based on the amount of liabilities held at a financial institution.

Automakers and AIG, some of TARP's largest recipients, would likely be exempt from having to pay the fee, the source told Reuters.

SOURCES: Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Reuters


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