Despite a focus by global regulators on preventing compensation models from encouraging excessive risk taking in the financial industry, recent turmoil in the banking sector suggests more work needs to be done, according to a new report from the Financial Stability Board (FSB).
The FSB report said the failure of several U.S. banks, and the forced marriage of Swiss banking giants, Credit Suisse and UBS, in early 2023, highlighted one of the central lessons of the financial crisis — that bankers’ pay needs to be “aligned with prudent risk-taking.”
In particular, the collapse of Silicon Valley Bank and Credit Suisse underscored the importance of principles designed to separtate compensation models from risk taking, the report said.
Compensation tools are central to preventing misconduct by providing incentives for good conduct in the first place, and by creating mechanisms to ensure accountability by enabling banks and regulators to remediate bad behaviour that’s uncovered after the fact, the FSB noted.
“Compensation and related performance management mechanisms help signal the importance that financial institutions place on prudent management of risk and on standards of behaviour, including compliance with related laws, regulations and supervisory expectations,” it said.
The report looked at the progress that various jurisdictions have made at adopting effective compensation frameworks since the financial crisis, and it found that there remain a variety of legal and regulatory obstacles to actually using these tools — particularly provisions to clawback compensation that was paid for performance that is later discovered to involve excessive risk taking, or other misconduct.
Given its findings, the report also sets out possible solutions to these challenges, including strong board oversight, building cultures that prioritize accountability and strong risk management, clear communication of compensation frameworks and their alignment with firm performance and risk management, and the role of regulators in fostering sound corporate cultures.