New risk from new rules on banker pay
In April, a joint committee of federal regulators issued their long-awaited proposed rule limiting incentive-based compensation for bankers. The rule, part of the larger Dodd-Frank Act, largely reflects the industry trends in executive compensation over the last few years, but the key difference is the breadth of impact. This regulation, as it stands, will impact more employees than just the C-Suite executives the average citizen imagines as a “banker.”
This document would require the largest banks to withhold 60% of all incentive-based pay for impacted employees for four years and includes a seven-year claw-back provision for bonuses paid if it is later determined that an employee’s actions caused losses. The rule applies to Fannie Mae, Freddie Mac, depositories, broker-dealers and credit unions with $1 billion or more in non-client assets. Institutions whose assets are largely those of clients, such as mutual fund and hedge fund firms, will see minimal changes from the rule.
Here are some key points to consider when evaluating the proposed rule:
Impacted employees. Regulators have set their sights on “risk-takers” instead of the title-based concept of “executives.” The rule will impact employees who initiate activities generating risk of material financial loss and who receive incentive-based compensation sufficient to influence their risk-taking behavior. For banks with non-client assets totaling over $250 billion, this would include the top 5% of the highest paid employees who receive more than a third of their compensation based on incentives.
Defining the top 5%. That’s hard to do, as the compensation of bank employees is not publicly known. According to the Wall Street Journal, the top 5% of employees by pay at the six largest U.S. banks is almost 52,000 people. The top 5% of income earners in the U.S. across all industries earn about $179,759 in adjusted gross income per year. For comparison, that is about $5,000 less than the median salary for a general practice physician in the U.S. This is not your CEO-level compensation package.
The purported regulatory goal is to discourage excessive risk-taking by increasing individual accountability for decisions that cost the institution money. Public comment is open until July 22, but may be extended. The American Bankers Association expressed concern in its comment about the government balancing its “interest in discouraging excessive risk-taking with a firm’s liberty to make business judgments for the benefit of its owners.” The U.S. Chamber of Commerce Center for Capital Markets Competitiveness decried the lack of a required economic analysis in the proposed regulation. There were 23 form letters received from individual citizens approving of the rule as a good first step but encouraging further restrictions.
To anticipate the potential consequences of this rule, we can look to the UK. While the impact of Britain exiting the European Union is currently unknown, the European Banking Authority did strengthen the European Union’s bonus caps in 2015, which resulted in higher fixed salaries for bankers in the UK. We can likely expect a similar compensation shift here, but we could see additional compensation in the form of restricted share stock that vests over time.
This shift toward fixed income may have unintended consequences, including less institutional flexibility to cut costs in case of a financial downturn and potentially limiting long-term employee self-investment and behavioral motivations that the bonus structure was initially designed to support. There is also a fear, articulated in the public comments and in the media that the top finance graduates will veer away from careers in traditional banking and move toward hedge funds and FinTech not impacted by the rule.
It remains to be seen whether the rule will truly mitigate risk and protect the public interest or whether the predicted unintended consequences will result in new areas of risk to consumers.