Fed eyes wide-ranging bank pay rules to fight risk

The Federal Reserve is reflected in a car as a security officer patrols the front of the building in Washington, June 24, 2009.

WASHINGTON (Reuters) - The Federal Reserve plans new rules on bank pay to curb the type of excessive risk-taking that sparked the global financial crisis and triggered international demands for action.

Public outrage at the stratospheric compensation of some bankers has boiled up to the level of the Group of 20 nations, whose leaders meet next week in Pittsburgh.

The United States, under pressure to act on pay at the G20 from France and Germany, has already said it aims to curb the culture of excessive risk-taking at the root of the crisis.

A Fed source said on Friday that guidelines would be proposed in the next few weeks and would apply to any employee able to take risks that could imperil an institution, not just the executives who have been the main target of popular ire.

The rules will be aimed at all firms the Fed regulates and be enforceable under its existing powers, said the source, who requested anonymity. The Fed oversees more than 5,000 bank holding companies and over 800 smaller state-chartered banks.

Massive losses inflicted by risky subprime mortgage bets destroyed some of the oldest names in U.S. finance and intensified a recession that has cost millions of jobs, putting both the banks and the regulators under scrutiny.

The Financial Stability Board, which answers to the G20 and will issue guidelines at the September 24-25 summit, said on Tuesday that poorly capitalized banks should not be allowed to pay large bonuses.

MULTIPLE TRACKS

The Obama administration has already appointed a "pay czar" to oversee executive compensation at firms getting taxpayer aid, and has indicated it will take further steps.

"Properly designed compensation practices constitute an important measure in ensuring safety and soundness in our system," White House adviser Lawrence Summers said on Friday.

Industry officials said many financial firms had already reined in pay practices and warned a heavy-handed approach by the Fed could be harmful.

"What we're worried about is if they place undue restrictions on the sales people because that could weaken the company itself," said Scott Talbott, senior vice president for government affairs for the Financial Services Roundtable, the industry's lobbying group.

Some analysts said Washington was bowing to populist pressure. "I think that talking about curbing Wall Street pay is emotional and not rational," said Tom Sowanick, co-president and chief investment officer of Omnivest Group LLC.

The Fed's proposal would take a two-pronged approach. A top tier of the largest banks, numbering around 24, would get particularly close scrutiny, while all other lenders under the Fed's supervision would receive less-intensive treatment.

Larger firms would also be subject to a review that would compare their practices against rivals, and would be required to submit their pay policies to the Fed for its approval.

This would put the burden on the big firms to modify existing compensation practices, while leaving them with flexibility to customize compensation to best fit their needs.

Practices at smaller banks would be reviewed as part of existing regular bank exams, the Fed source said.

PLACING THE FOCUS ON THE LONG RUN

Goldman Sachs, which set aside $11.3 billion in the first half of the year toward employee bonuses but which has also spoken out against excessive pay at firms that lost money, said excessive risk-taking should not be rewarded.

"We think it entirely appropriate that people are rewarded for performance, but compensation should correlate directly with the performance of the firm," said Goldman Sachs spokesman Lucas van Praag.

The Fed board has yet to vote on the proposal, but the timeline for the guidelines should advance in weeks, not months, the source said.

The proposed rules would then face a period of public comment before they could be made final. But the Fed plans to launch the review process for the large firms as soon as the proposal goes out, the source said.

The guidelines would not apply a one-size-fits-all prescription to cap pay at any specific level, the source added. Rather, the guiding principle would be to aim for a longer view of profits that squeezes out risk-taking that might lead just to short-term gains.

Officials are also discussing the possibility of "clawing back" compensation when it later becomes apparent excessive risks were taken.

It plans to outline ways to defer pay, for example by using restricted shares that take longer to vest, which would give bank management more time to judge if the revenues from a particular activity really lived up to expectations.

It will also point out the ability to weigh compensation according to the riskiness of the activity involved, as some already do to internally allocate capital.

(Additional reporting by Karey Wutkowski in Washington and Jennifer Ablan and Steve Eder in New York; Editing by James Dalgleish)