Federal regulators ""proposed a new rule"":http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110330a1.pdf Wednesday that would require certain financial institutions, including large mortgage lenders, to account for risk as they structure incentive compensation packages for executives and employees.
[IMAGE]New rules for risk-based pay are a mandate of the Dodd-Frank Reform Act and are aimed at stemming the type of business practices and management decisions of some firms during the years leading up to the housing collapse and the financial crisis, in which executives engaged in high-risk behavior for short-term gains without considering the long-term upshot.
Many economists blame incentive pay schemes for the risky lending and investment gambles that pushed the nation's financial system to the brink of ruin because in their design, many executives were rewarded for fast, not sustaining, results.
[COLUMN_BREAK]The proposed rule from U.S. regulators would apply to financial institutions with more than $1 billion in assets.
The agencies are also proposing that larger financial institutions, those with $50 billion or more in assets, defer at least 50 percent of the incentive compensation of certain officers for at least three years.
For credit unions, large financial institutions subject to the deferral would be defined as those with $10 billion or more in assets. The Federal Housing Finance Agency (FHFA) proposed that the income-deferral provisions apply to all entities it regulates, regardless of size, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.
The regulatory agencies explained that in prohibiting incentive compensation arrangements that could encourage inappropriate risks, the proposal would require compensation practices at regulated financial institutions to be consistent with three key principles -- that incentive compensation arrangements should appropriately balance risk and financial rewards; be compatible with effective controls and risk management; and be supported by strong corporate governance.
In addition to FHFA, the proposed rule was issued by the Federal Reserve, FDIC, National Credit Union Association, Office of the Comptroller of the Currency, Office of Thrift Supervision, and the Securities and Exchange Commission.
The agencies are requesting comments on the proposed rule over the next 45 days.