Two years later, there has been only modest change, according to the findings of a long-awaited Federal Reserve report on bank compensation practices.
In the 27-page report released on Tuesday, Federal Reserve officials heralded a series of incremental improvements that showed big banks were delaying the payouts of a greater portion of their compensation, with senior executives now deferring more than 60 percent of their bonuses.
But most of the 25 large banks in the Fed’s review still do not adjust bonuses to fully reflect the riskiness of the bets made by bankers and traders. Some of the potential conflicts of interest that regulators initially flagged — like having risk managers report to executives who have influence over their year-end bonuses — still remain.
“Every firm needs to do more,” the report concluded.
The review was focused on the structure of pay, not on how much bankers made. It began as an effort to curb excessive risk-taking and reckless compensation practices that many cited as a leading cause of the housing boom and the subsequent market bust. At the time, the Fed itself was also coming under pressure from lawmakers who blamed its lax oversight of the banks as another cause of the collapse. Analysts suggested that the high-profile compensation review would show that the financial police were back on the beat.
But pay has quickly rebounded since the worst of the 2008 crisis — although experts project that 2011 bonuses will drop at least 10 to 30 percent from last year because of the slowdown in trading, lending and fee income, according to Johnson Associates, a Wall Street compensation advisory firm. Critics charge that the Fed’s review does little to impose tough measures.
“It’s surprising to learn that practices that the Fed raised as problematic two years ago are still going on,” said Robert Jackson, a Columbia Law School professor and senior adviser on executive compensation in the Obama administration until last fall. “We are still waiting for hard evidence of any real change.”
For example, when Fed officials began their review in November 2009, they said that risk managers should be more involved in setting pay. Two years later, the report found “at some firms, risk experts primarily play a peripheral or informal role.”
Some concerns flagged by regulators early in the examination appear to have gone unaddressed. In letters to the banks documenting the review’s preliminary findings sent last spring, Fed examiners found that risk managers at several of the biggest banks still reported to executives who had influence over their year-end bonuses and whose own pay might be constricted by curbing risk.
Some banks have established separate bonus pools and incentive plans for risk and compliance officials, not directly tied to the financial performance of their business unit. Other big banks, according to the Fed report, have yet to take such action. The review encompassed Bank of America, Citigroup, Goldman Sachs and 12 other large lenders as well as the United States operations of nine large foreign banks like Barclays, Deutsche Bank and UBS. However, the report did not single out individual institutions.
The Fed report also found other signs of strained progress. Companies remained in the dark on the pay arrangements of workers lower down in the organization whose decisions could have a potentially devastating impact on the bank. Just over half of the 25 banks, in fact, had even identified groups of highly paid employees whose combined efforts could potentially put the firm at risk. “Some firms are still working to identify a complete set of mid- and lower-level employees and fully assess the risks associated with their activities,” report said.
At the start of the review, examiners also found that no firm had a well-developed strategy for adjusting payouts to account for risks taken by employees like traders or mortgage lending officers. Today, only a few banks are using sophisticated internal metrics that would lower the size of payouts to account for the riskiness of the bets.
The report provided few prescriptive measures for the banks and was vague about the timetables for adopting changes. For example, the report said the banks must continue to work on developing “appropriate policies and procedures to guide judgmental adjustments” to bonus payouts.
Under pressure from regulators, firms have installed claw-back policies and other measures that would later reduce bonus payouts in the event of large losses. Sixty percent of senior executive compensation is now deferred, and for some it is as much as 80 percent, the report said. That is up from about 40 percent before the 2008 financial crisis, according to compensation experts. As for next steps, the Fed said it would “monitor and encourage progress.” But it left it to the banks to “evaluate how well these deferral arrangements have worked and make improvements as necessary.”
The Fed hinted in the report that there might be better information about banker bonuses in the months ahead. It plans to use new disclosure requirements known as Basel Pillar 3 that call for, among other things, the publication of the number of bankers receiving bonuses at each firm, the number of bonus guarantees and the number of severance payouts.
Still, some suggest the Fed’s recent effort will do very little to improve pay practices. “The cost of this exercise has been enormous and the benefits have been quite small,” said Alan Johnson, a compensation consultant who specializes in the financial services industry.
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