Most financial institutions would need to review compensation standards for its executives under proposed guidance released Thursday by the Federal Reserve Board.

The proposal does not cap pay levels at any institution or tell banks how their compensation packages should be structured, but it has several far-reaching elements, including separate reviews of large and small banks and broad guidance.

Its release coincides with moves by the Treasury Department's pay czar, Kenneth Feinberg, to impose pay curbs at companies that have received exceptional government assistance.

But while Feinberg's upcoming announcement will affect just two banking companies — Bank of America Corp. and Citigroup Inc.—the Fed's proposal would touch hundreds of financial institutions in all corners of the United States.

The Fed said it would subject 28 unnamed "large, complex banking organizations" to a "horizontal review" of compensation policies and practices. The review is designed to better understand compensation trends in the industry and identify firms whose practices fall outside the norm.
The Fed and other banking regulators conducted a similar review of the 19 largest financial institutions earlier this year to determine which banks needed to raise more capital.

Regional and community banks will also come under scrutiny, but the Fed said supervisors will review pay practices at these firms as part of the regular examination process. The central bank said small banks' pay will not be compared against competitors, but the review could impact the supervisory rating assigned to a bank.

More broadly, the Fed is proposing guidance for banks to help them develop proper pay practices. The guidance says banks should consider three goals: provide incentives that discourage excessive risk taking, match "effective controls and risk management" and support strong corporate governance.
The Fed said its guidance is aimed at senior executives and individuals or groups who could expose the bank to risk.

"Compensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability," Fed Chairman Ben Bernanke said in a press release. "The Federal Reserve is working to ensure that compensation practices appropriately tie rewards to longer-term performance and do not create undue risk for the firm."

Once the guidance is published in the Federal Register, the public will have 30 days to comment. Though the Fed steered clear of specific caps in the proposal, it does seek comment on whether "formulaic limits" should be imposed on banks.

This story has been reprinted with permission from American Banker.

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