Banker Pay Curb: A Precaution?

Finally, the Federal Deposit Insurance Corp. (FDIC) has awakened to enforce limits on bankers’ pay. According to proposed rules issued by the FDIC earlier this week, top executives at mega banks will now have to bear a long wait—for at least three years—to get half their annual bonuses.

This is an effort to restrain excessive risk-taking by banks, which was one of the crucial reasons that sparked off the 2007–2009 financial crisis. The FDIC was bulldozed into taking this action following a provision in the Dodd-Frank financial regulation bill that was signed into law in July 2010.

According to the law, regulators have the authority to veto any bonus plan of financial bigwigs that incites out-of-place risks. Also, the plan to clamp down bank bonuses is a response to the principles agreed by the world’s group of 20 leading economies (G20) in 2009.

What are the Proposed Rules?

According to the latest rules, bank executives and traders,whose decisions may put their institutions at significant risk, would have to defer at least half of their bonus for a minimum of three years. If their institutions eventually suffer a loss as a result of their decisions, they could lose their future payment.

Paying bonuses in full would perhaps be a short-term hutzpah, considering the market volatility. If a company incurs insufferable losses caused by executives and decides to penalize them, paid bonuses will not be immediately revocable for many executives.

Also, under the new rules, the mega banks will have to pay a greater portion of their fees to the FDIC to insure other U.S. banks. This will considerably strengthen the deposit insurance fund meant for protecting customer accounts. When a bank collapses, the FDIC reimburses deposits of up to $250,000 per account.

The Health of the FDIC

The FDIC insures deposits in 7,760 banks and savings associations in the country, promoting the safety and soundness of these institutions.

Though the FDIC has managed to shore up its deposit insurance fund during the last few quarters, the outbreak of bank failures has tested its limits. As of September 30, 2010, the fund remained in the red with a deficit of $8 billion despite adding $7.2 billion during the quarter.

Increasing loan losses on commercial real estate are expected to result in hundreds of bank failures in the forthcoming years. Going by the current rate of bank failures, the FDIC is likely to feel a $52 billion pinch over the next three years.

Soft Targets

Deferred payment for senior executives will be applicable for banks with at least $50 billion in assets. The rules would cover mega banksincluding Bank of America Corp. (BAC), JPMorgan Chase & Co. (JPM), Goldman Sachs (GS) and Morgan Stanley (MS). After all, the fire that these banks played with spread the recent financial crisis like wildfire.

At Par With International Standards

The rules proposed by FDIC are basically a part of the recent global move.The enactment of the rules is expected to make the U.S. compensation standardssomewhat linear with other countries. However, the compensation control in the U.S. will be softer than the European Union. Rules set by the European Union in December 2010 decreed that top banking executives will get about 20% of their annual bonuses in cash in the short run and the remaining in the long run.

In the U.S., the proposed rules will apply to both domestic and overseas branches of the financial institutions under the scanner. As a result, the U.S. banks will enjoy an advantageous position compared to their European Union competitors, who had to bow down to a much stricter verdict.

A Step for Better Tomorrow

We have already seen how the daredevilry of many executives led to the financial catastrophe. As these executives had already pocketed most of their awards in the short term, they did not care much the echoing problems of their risk taking.

Following the financial crisis, most financial companies have voluntarily taken the initiative to reduce the amount of their cash bonuses. Now, the compulsion to defer bonus payment will probably keep another financial exigency under control.

In fact, compensation in the form of stock or deferred payment will encourage executives to take care about their company’s long-term prospects.

It is our belief that the curb on pay structure would provide more liquidity to the financial companies as majority of the awards to executives would not be in the form of cash advances. However, less cash payment could make these companies less competitive in retaining talent. Nevertheless, net results of the new rules are expected to guide the economy out of the woods.

By: Kalyan Nandy

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