Pub. 5 2010-2011 Issue 2

July/August 2010 19 Extraordinary Service for Extraordinary Members. programs include the use of risk adjustment of awards, deferral of payment, longer performance periods, and reduced sensitivity to short-term performance. Existing program features such as “golden parachutes” and the vesting arrange- ments for deferred compensation should be reviewed for their impact on “risk-taking behavior.” 5. Communications to employ- ees are important to ensuring the incentive compensation programs’ success. Communi- cations regarding the relationship between risk and payment should be a high priority. 6. Supporting the incentive pro- gram design should be ap- propriate risk management practices and board involve- ment and oversight. Integrity in the risk measures must be ensured. There should be regular reviews and oversight of the compensation programs, including the input of relevant parties related to risks. The guidance states, “The board of directors of an organization is ultimately responsible for ensur- ing that the organization’s incen- tive compensation arrangements are appropriately balanced and do not jeopardize the safety and soundness of the organization.” The board should receive regular reports that review compensation programs and awards relative to risk outcomes. “While the retention and use of outside parties may be helpful, the board retains ultimate responsibility for ensuring that the organization’s incentive compensa- tion arrangements are consistent with safety and soundness.” 7. A systematic approach, partic- ularly for large organizations, is recommended. The systematic approach includes: identifying em- ployees who may expose the orga- nization to material risks, either singly or as a group; identifying the types and time horizons of risks impacted; identifying and including performance measures and other mechanisms to address risk taking; communicating with employees about the plan; and monitoring, oversight, and modification of the programs over time. Next Steps to Take Compliance with the guidance will take more effort for some banks than others. Banks that have engaged in risk quantification efforts in the past will find the requirements outlined by the Fed represent an extension of those efforts into the management system of the bank (i.e., planning, budgeting, metrics, and rewards). While the process may seem foreign to some banks, the type of programde- sign articulated in the Fed guidance is workable and, properly implemented, will add value to the firm’s strategy processes and risk management struc- tures overall. The first step, or challenge, for the bank is clearing the mental hurdle of wanting to make the change. To some extent, the Fed, by setting forth the guidance, creates that will. Even with the stated objective, however, each bank will need to work on laying the groundwork within the institution. The steps outlined by the Fed as a systematic approach make sense. Determining the groups to be cov- ered, such as relationshipmanagers and executives, helps to set the parameters for the risk and metrics quantification. If new to the bank, risk quantification will be one of themost time-consuming elements of the process. Developing the performance met- rics comes next and should include a careful review of the consequences, intended or not, of any metric de- signed. For example, many banks are familiar with RAROC (risk-adjusted return on capital) measures. These Q Compensation Policies — continued on page 20