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Like a robust flu virus that just won’t go away, the federal government continues to propose new, vague regulations over banking industry pay practices.
Last week, a source from the Fed said the agency would propose guidelines aimed at curbing the “culture of excessive risk-taking” at the nations over 5,000 federally-insured banks. Such rules apparently apply to any employee, such as lending officers, able to take risks that could impact the institution.
It’s hard to say how the Fed will guide incentive pay practices for sales-type functions. Something akin to the Transportation Security Administration (TSA) as the government’s response to 9/11 comes to mind. I think sales incentives are the box-cutter equivalent to the industry’s woes – sure they played a role, but the system’s failure came down to a broader, and not soon-to-be repeated, set of circumstances.
And just as focusing exclusively on reinforced cockpit doors may have provided a more cost-effective solution to keeping our skies safe from hijackers, requiring that banks disclose what products provide incentive pay is as deep as the government needs to go here.
For years, the SEC and NASD (now FINRA), have issued guidelines for the pay practices of registered financial advisors. While these agencies do not require full disclosure, some prudent brokerage firms publish details of their advisor pay plans in pamphlets made available for clients, not unlike the information in proxy disclosures regarding executive compensation. These agencies periodically audit the pay history of brokers, looking for incentive earning trends at the product level.
While the system has enabled brokerage firms to establish and manage competitive cash incentive plans, it’s cumbersome and potentially not feasible when applied to the entire commercial banking industry. There’s a difference, also, in the responsibilities between financial advisors and lending offers. Financial advisors offer a broad array of instruments to their clients who are concerned, generally, with managing their money. Loan officers represent a more specific product – loans – that must meet the bank’s credit standards, as must the prospective consumers of those loans. Most loan officers will tell you, getting loans approved through the bank’s underwriting is a much regulated process.
Of course stories abound of loan officers back in the salad days selling subprime residential mortgages, instruments widely heralded as the watershed for our current economic crises, that preyed on unsuspecting consumers and misrepresented the product. Critics will point to the incentive schemes that drove this behavior. But behind the motivated salespeople and relaxed lending standards was government policy that encouraged lending to subprime consumers. Apropos that the government now fixes its own mess, yet I hardly see how making salespeople indifferent to what or how much they sell is going to help.
So what’s management to do with yet another vague set of pending guidelines? A common response to the TARP regulations was to do nothing. Seldom is do-nothing a good approach, and in a highly scrutinized yet competitive industry, it’s a recipe for bad publicity, bad business, or both. Banks should not aim to create a risk-adverse sales culture. Salespeople thrive on risk, and the incentive plan is a key component. To stay off the Journal’s front page, banks should ensure they are able to disclose, when so requested and at a high level, the way in which they pay each salesperson, including the pay differential between average and top salespeople in each job role, and the products eligible for incentive pay. And banks should prepare to report, down to the individual salesperson level, the source and amount of each incentive pay dollar.
Sometimes the government is effective for getting us to do things we should be doing anyway, like wearing seatbelts (no disrespect to the independently-minded citizens of New Hampshire). Being able to explain how you pay your salespeople is good compensation practice, and good business. Yes, companies without the systems for doing so must spend a decent sum to enable this capability. But the cost pales in comparison to having unmotivated salespeople. Voluntary disclosure, not heavy-handed incentive design regulation, provides the most practical solution. Let’s avoid another TSA when reinforced cockpit doors will do the trick.
Scott Barton is a management consultant specializing in incentive design and management for the banking industry. Write to him at scottbarton22@gmail.com
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