NEW YORK (CNNMoney.com) -- The nation's top banking regulators issued final guidelines Monday aimed at making sure that compensation practices at financial institutions do not encourage excessive risk taking.
The guidelines, which will be enforced by the Federal Reserve, are backed by the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.
The Fed proposed the recommendations last year in response to the financial crisis, which it said was caused in part by skewed compensation practices. The goal, regulators said, is to help safeguard the financial system against future shocks by linking compensation to long-term performance rather than short-term profits.
"Many large banking organizations have already implemented some changes in their incentive compensation policies, but more work clearly needs to be done," Federal Reserve Governor Daniel Tarullo said in a statement.
According to the final guidelines, compensation plans should "appropriately balance risk and financial results" so that bankers are not encouraged to expose firms to "imprudent risk."
In addition, financial firms should have the right risk management strategies to ensure that compensation plans are balanced. The guidance also calls for "strong corporate governance" to help rein in risk, including a provision that says bank boards should approve compensation plans for senior executives.
As part of a review of compensation at several large U.S. financial firms, the Fed said it delivered assessments of current compensation practices last month. Those firms are now submitting plans to the Fed on what steps they are taking to discourage excessive risk-taking.
"The Federal Reserve expects firms to make material progress this year on the matters identified as we work toward the ultimate goal of ensuring that incentive compensation programs are risk appropriate and are supported by strong corporate governance," said Tarullo.
In the next phase of its ongoing investigation, the Fed and other agencies will be zeroing in on compensation plans in certain sectors of the financial services industry, such as mortgage originators.
The agency also pledged to keep up pressure on banks in areas where progress has been "deficient," including identifying employees or groups that pose the biggest threats and applying risk-curbing practices more widely.
In addition, regulators said that many banks are using a "one-size-fits-all" approach to compensation deferral arrangements, which are designed to keep bankers focused on long-term goals. These agreements should be tailored to the type and duration of risk, according to the agency.
Many banks also do not have "adequate mechanisms" to gauge whether established practices are successful in balancing risk, the agency said.
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