Today, the Federal Reserve published in the Federal Register proposed guidance on incentive compensation policies at banking organizations (the "Guidance"). The Guidance is based on three key principles that attempt to ensure that incentive compensation arrangements at banking organizations do not encourage excessive risk taking and are consistent with the safety and soundness of the organization. This guidance applies to incentive compensation not only for senior executives, but also for individual employees, or groups of employees, who may expose the institution to material amounts of risk. The three principles are:
Banking organizations should provide employees incentives that do not encourage excessive risk taking beyond the organization's ability to effectively identify and manage risk; Incentive compensation arrangements should be compatible with effective controls and risk management; and Incentive compensation arrangements should be supported by strong corporate governance, including active and effective oversight by the organization's board of directors. The Federal Reserve expects all banking organizations to evaluate their incentive compensation arrangements for consistency with these principles and to take immediate actions to address any deficiencies. The Federal Reserve will, on an ongoing basis, also assess whether banking organizations' incentive compensation arrangements are compliant with these principles.
Furthermore, the Federal Reserve has announced two new supervisory initiatives designed to encourage and monitor the banking industry's progress towards implementing safe and sound compensation arrangements, identify emerging best practices and advance the state of practice generally. These supervisory initiatives are:
A special "horizontal review" of incentive compensation practices at large complex banking organizations ("LCBOs"); and A review of incentive compensation practices at non-LCBOs as part of the risk-focused examination process for these organizations. This memorandum briefly outlines the Federal Reserve Guidance and supervisory programs.
Incentive Compensation Guidance The Federal Reserve's goal is for incentive compensation arrangements to be consistent with principles of soundness and safety, and for such arrangements to take into account potential risk and risk outcomes. To that end, the Federal Reserve has developed three key principles which structure the Guidance, as noted...