Bankers are reducing their use of big unconditional payouts to hire and retain staff and instead are trying to set pay more in line with long-term performance to avoid undue risk-taking, according to a new report on the industry.

An international survey of wholesale banks found that most are now implementing compensation systems in line with the standards published by the Financial Stability Board in September 2009. Substantial changes are taking place in governance, risk adjustment and deferred pay-outs, the report said. 

The Institute of International Finance report on compensation in the financial services industry uses responses from 37 financial services firms. These have been supplemented by a series of individual interviews. Between them, these institutions represent 70 per cent of total global wholesale banking revenues for 2009.

The IIF stated: “We are seeing greater emphasis to ensure that incentives are linked to performance and are aligned with shareholder interests. Importantly, we do not see this as restricting the level of compensation, but that banks adopt policies to ensure that incentives do not induce risk-taking in excess of the firm’s risk appetite.”

Since early 2009 there has been a dramatic increase in the involvement of the risk and control functions in setting front-office compensation. Risk management involvement in the compensation process has risen from slightly less than half of the firms in 2008 to almost all firms in 2010. The risk function is now contributing, in varying degrees, to policy reviews, determining the suitability of performance metrics, establishing compensation formulae and signing off on the risk-appropriateness of incentive plans.

The survey found that progress on the key area of pay-out structures has been significant, with substantial improvements including increased use of instruments aligned with the long-term performance of the firm or business unit, and increased recourse to non-cash instruments. In particular, the use of deferred compensation has doubled to 39 per cent of the compensation pool: 85 per cent of surveyed banks are now using deferral periods of three years or more and are tiering deferral rates so that the remuneration of the most senior and highest paid executives is deferred for longer; nearly 70 per cent of deferred compensation is paid out in stock or stock-linked instruments.

Unconditional payouts have been reduced by half, with the remainder focused on new hires; multi-year guarantees have been all but eliminated; of the 15 per cent of firms that had some form of a "golden parachute", most have taken steps to eliminate them.