Incentive Compensation: Interagency Guidance on Sound Incentive Compensation Policies

The guidance attached to this bulletin continues to apply to federal savings associations.

The Office of the Comptroller of the Currency (OCC), along with the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision, is issuing the attached guidance on sound incentive compensation policies and practices.  The guidance is intended to assist banking organizations in designing and implementing incentive compensation arrangements that do not encourage imprudent risk-taking and that are consistent with the safety and soundness of the organization.¹   The guidance is effective June 25, 2010.

Incentive compensation arrangements can be useful tools in the successful management of banking organizations.  However, compensation arrangements can provide executives and employees with incentives to take imprudent risks that are not consistent with the long-term health of the organization.  Flawed incentive compensation practices in the financial industry were one of many factors contributing to the financial crisis that began in 2007.  Banking organizations too often rewarded employees for increasing the organization’s revenue or short-term profit without adequate recognition of the risks the employees’ activities posed to the organization.

To be consistent with safety and soundness, incentive compensation arrangements at a banking organization should comply with the following principles:

• Provide employees incentives that appropriately balance risk and reward;
• Be compatible with effective controls and risk management; and
• Be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The OCC expects national banking organizations to regularly review their incentive compensation arrangements for all executive and non-executive employees who, either individually or as part of a group, have the ability to expose the organization to material amounts of risk, as well as to regularly review the risk-management, control, and corporate governance processes related to these arrangements.  Banking organizations should immediately address any identified deficiencies in these arrangements or any processes that are inconsistent with safety and soundness.

Because of the size and complexity of their operations, large banking organizations (LBOs)² should have and adhere to systematic and formalized policies, procedures, and systems for ensuring that the incentive compensation arrangements for all executive and non-executive employees covered by this guidance are identified and reviewed, and appropriately balance risks and rewards.  In several places, this guidance specifically highlights the types of policies, procedures, and systems that LBOs should have and maintain, but that generally are not expected of smaller, less complex organizations.  LBOs warrant the most intensive supervisory attention because they are significant users of incentive compensation arrangements and because flawed approaches at these organizations are more likely to have adverse effects on the broader financial system.  The OCC will work with LBOs as necessary through the supervisory process to ensure that they promptly correct any deficiencies.

The policies, procedures, and systems of smaller banking organizations that use incentive compensation arrangements are expected to be less extensive, formalized, and detailed than those of LBOs.  Supervisory reviews of incentive compensation arrangements at smaller, less complex banking organizations will be conducted by the OCC as part of the evaluation of those organizations’ risk management, internal controls, and corporate governance during the regular, risk-focused examination process.  These reviews will be tailored to reflect the scope and complexity of an organization’s activities, as well as the prevalence and scope of its incentive compensation arrangements.  Little, if any, additional examination work is expected for smaller banking organizations that do not use, to a significant extent, incentive compensation arrangements.

For all banking organizations, supervisory findings related to incentive compensation will be communicated to the organization in the relevant supervisory letter or report of examination.  In addition, these findings will be incorporated, as appropriate, into the organization’s rating component(s) and subcomponent(s) relating to risk management, internal controls, and corporate governance under the CAMELS rating system, as well as the organization’s overall composite rating. 

For further information, contact Karen M. Kwilosz, Director, Operational Risk Policy, at (202) 649-6550, or Reggy Robinson, Policy Analyst, Operational Risk Policy, at (202) 649-6550.

                       /signed/                          

Timothy W. Long
Senior Deputy Comptroller for Bank Supervision Policy
and Chief National Bank Examiner

Related Link

• Interagency Guidance