What Executive Pay Means for Your Bank

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Wall Street is shaking in its wing-tips this week after the federal government said it will restrict the paychecks of bank executives involved in big bailout deals.

That could lead to a talent drain at your bank, and more onerous regulations could crimp your bank’s ability to handle its own financial affairs — and possibly yours. Here’s a look at what might happen.

The numbers tell a story that big banks don’t want to hear. According to the U.S. Treasury Department, cash salaries paid to top-earning executives at seven banks that received federal bailout money will be capped at $500,000. Not all bank executives are impacted by the pay caps — only the highest-paid executives at banks like Citi (Stock Quote: C), Bank of America (Stock Quote: BAC), GMAC Inc. (Stock Quote: GJM), as well as execs at non-bank recipients of federal funds like AIG (Stock Quote: AIG) and General Motors (Stock Quote: GM).

The government is targeting the top-25 highest-compensated managers — 175 in all — at each of seven big companies who accepted government bailout cash.

The Treasury also estimates that the targeted managers will average 50% in total pay cuts, starting in November. Executives won’t have to pay back any money they’ve already received, and the pay caps will remain in effect until the companies pay their bailout loans back to the government.

What impact, if any, does the pay cap initiative have on your bank? It’s an interesting question with, unfortunately, some open-ended answers. Let’s take a look at the potential fallout.

Less risk for banks. The Federal Reserve is also looking at bank compensation, and may wind up tying executive pay to risk. Specifically, the more risks a bank’s senior executive takes with borrowed money, the less compensation he or she might receive, if the Fed gets its way. That could cause banks to grow more conservative, and tighten credit further.

Less cash, more stock. Bigger banks impacted by the pay cap initiatives may try to get around the salary limits by switching compensation from salary to stock options. That won’t affect you, as a bank customer, but it could keep high-priced financial talent on the job at your bank. Some bank industry observers have complained that the pay caps would lead to a “brain drain” on Wall Street. Switching compensation from cash to stocks could keep more talent at the big banks, although that argument is a tough one to make when top banking talent have made so many bad decisions in the past few years.

Smaller banks impacted, too. While large banks are drawing the most ire from Uncle Sam, small banks will soon feel the heat, too. While the Treasury pay cap focuses on TARP-linked banks, the Federal Reserve bank compensation review — which is run independent of the Treasury's review — will cover thousands of U.S. banks. Increased scrutiny by the Fed should result in heightened regulations on smaller banks, and could impact interest rate and lending policies at many banks with clean balance sheets that never took a dime from the government. Smaller banks, especially the managers who could see a pay cut under the imminent Federal Reserve compensation guidelines, won’t be happy with Uncle Sam peering over their shoulders.

No doubt, government-induced pay caps and tougher oversight are all part of the “new normal” that banks are learning, grudgingly perhaps, to accept. But for bank customers, the fallout shouldn’t be too severe. If anything, for an industry that had to have taxpayers bail it out after years of greed, hubris and ethical neglect, the experience should be humbling — and that’s a good thing for once high-flying banks.

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