Compensation and Risk: Regulation and Design of Incentive Schemes

José Luis López del Olmo

One key area of regulatory focus with regard to risk culture has been the issue of the structure of compensation arrangements in banks. In this vein, the Financial Stability Board (FSB) considers compensation practices that promote appropriate risk-taking behaviour as one of the three foundational elements that support a sound risk culture in financial institutions,¹¹FSB (2014). the other two being effective risk governance – including the roles and responsibilities of the board – and an effective risk appetite framework. This chapter therefore looks at the changing regulatory environment regarding incentive structures that affect the nature of the arrangements and the governance around them. It also explores challenges related to the design of an incentive-compatible remuneration structure for risk-taking businesses such as banks but which is also relevant for other industries.

Up until 2007, policymakers in general and prudential regulators in particular paid only limited attention to remuneration policies in banks. Before that, the limited references were largely in relation to broad corporate governance perspectives focused on listed companies. From 2007, and increasing in