The UK Financial Services Authority (FSA) today said that bank employees were given incentives to pursue risky policies to the detriment of shareholders, and ultimately taxpayers.In a letter to chief executives, the FSA added that this culture of risk taking was a root cause of the current turmoil, and called for banks to follow remuneration policies that are aligned with sound risk management practices.
The compensation packages received by high-level executives, irrespective of performance, have come under scrutiny in the past year, not only in the media but also by the likes of the European Commission and the Financial Stability Forum.
Increased supervision of remuneration schemes was also one of the preconditions of the UK government’s £50 billion recapitalisation of British banks. Upon unveiling the plan on October 8, UK Prime Minister Gordon Brown warned banks that: “Where there is irresponsible or excessive risk taking, we have to take action”.
The guidelines drawn out by the FSA focus on four areas: performance evaluation, composition of remuneration, deferred compensation, and oversight. Performance should be judged by profits and not revenues, with reference to other business goals where appropriate. There should be a measure of risk-adjusted return, likely to be based upon economic capital calculation. Meanwhile, as well as financial performance, criteria such as risk management skills should be borne in mind when awarding bonuses.
In order to align the interests of the employee and the firm, remuneration should be a mixture of cash and equity, with a significant proportion of bonuses paid out on a deferred basis to reflect an individual’s long-term performance.
When finalising the compensation packages of senior management, firms should appoint a board level remuneration committee, which should include a majority of non-executive directors.
In its statement, the FSA urges firms that are currently looking at remuneration processes for year-end reviews to align their policies with these guidelines. Nevertheless, the FSA stresses it is not its intention to set remuneration levels for banks, but to ensure policies are harmonised with sound risk management practices.
See also: Bankers' incentives blamed for crisis
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