Tarullo Says More Work Needed to Balance Bank Risk Incentives

Federal Reserve Governor Daniel Tarullo said more work needs to be done to better align the risk-taking incentives of employees inside financial firms with regulatory interests in preserving safety and soundness.

Stock-based rewards can “intensify the conflict” between the interests of shareholders and regulators, Tarullo said, as they put a high value on gains from risk-taking. Alternative proposals include some form of debt-in-compensation packages to give risk-takers more exposure to loss and failure, or clawback and forfeiture clauses triggered by government assistance or insolvency, he said.

Developing a mechanism that balances the goals of regulators while still “motivating employees to advance shareholder interests will take some work,” Tarullo said today in Washington in a speech to the Association of American Law Schools. “Some measure along these lines is key to adjusting incentives so as to promote prudential objectives across the many risk decisions made within the firm.”

Tarullo is the Fed governor in charge of bank supervision and regulation, and he has overseen the central bank’s implementation of the Dodd-Frank Act, a 2010 law that marked the most sweeping reform of financial rules since the 1930s. He didn’t comment on monetary policy in the text of his remarks.

The KBW Bank Index, which tracks 24 U.S. banks, including Capital One Financial Corp., JPMorgan Chase & Co., and M&T Bank Corp., is up 3.6 percent this year compared with a 5.7 percent gain for the Standard & Poor’s 500 Index.

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