Financial regulators certainly took their time, but proposed new rules to curb bankers’ bonuses are a welcome step toward changing a compensation culture that encouraged irresponsible risk-taking and helped set off the financial crisis.
The new rules, outlined by the F.D.I.C. last week, would require banks with more than $50 billion in assets to defer at least half of their top executives’ bonuses for at least three years. If the banks’ bets went bad, the executives would lose the unpaid portions. The same criteria would apply to the bonuses of traders and other employees whose activities could put their banks at risk.
The sound idea is that bankers’ remuneration should match the risks they take on. That should help discourage them from doing deals that produce big short-term profits (and up until now big immediate bonuses) only to fall apart a few years down the line.
Banks would have to file annual reports on their incentive compensation, and regulators could demand changes to pay structures. Smaller banks would not have to meet specific targets on deferred bonuses, but they would have to ensure that incentive compensation aligned pay with risk, and report to regulators yearly.
The rules are good, but they could be better. The European Union agreed to new rules last year that require European banks to defer 40 to 60 percent of top bankers’ bonuses for three to five years and pay as much as 80 percent of their remuneration in equity rather than cash.
Since the meltdown, most big American banks have adjusted their compensation structure and already meet the new criteria. The good news here is that regulators are finally acknowledging that their laissez faire approach to bankers’ compensation helped drive the crisis. The regulations also mean that banks and bankers cannot as easily slip back into their bad habits once the good economic times return.
For the new rules to take effect, they must be formally approved by all the regulators involved in their making, including the Federal Reserve and the Securities and Exchange Commission. Then the public has 45 days to comment before final rules are published. Bonuses for 2010 have already been decided. We urge regulators to get the rules in place long before the 2011 bonus season gets under way.
