Will the Fed Regulate Investment Banking Salaries?

Word is out that the Federal Reserve is proposing to oversee the pay policies for tens of thousands of bank employees nationwide, in an effort to curb risk-taking by financial institutions.

Under the new proposed guidelines, the Fed could reject any compensation policy it feels encourages bank employees, from CEOs to traders to loan offers, to take too much risk. It wouldn’t set the actual pay levels, but could amend each bank’s salary and bonus policies to make changes, according to a report in the Wall Street Journal.

About 25 of the nation’s largest banks would be under particular scrutiny. The Fed plans to compare their compensation practices as a group to see if any of them stand out as being too risky.

The final proposal is still weeks away. Many critics in Congress, especially Republications, argue that the Fed is overstepping its reach. Compensation for banking jobs became a flash point during the recent financial crisis.  But as the economy rebounds and markets rise, we have seen salaries and compensation at some of the big banks (Goldman Sachs, for example) rise to pre-crash levels, as the banks strive to reward their top talent.

The proposed plan could also include “clawbacks” to reclaim compensation from staff who take risks that damage their firms. Or the government may demand that a greater portion of executive pay be in the form of restricted stock or long-term compensation, designed to avoid incenting people to take short-term risks.

President Barack Obama, Treasury Secretary Timothy Geithner and Fed Chief Ben Bernanke have all criticized executive compensation for having pushed employees to take short-term risks with little regard for the long-term effect on their companies and clients.

However, the WSJ article quotes Scott Talbott of the Financial Services Roundtable, a trade group of financial companies, as warning: “Given the changes the industry has already done, if the restrictions on income-producers or salespeople are too draconian, it will actually undermine the strength of the institution.”

The Federal Reserve regulates more than 5,000 bank holding companies, which include the nation’s largest banks, as well as hundreds of smaller, state-chartered institutions.

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