Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the financial crisis of 2008. Accordingly, academics and lawmakers have called for the reform of banker pay practices. But regulator pay is to blame as well, and fixing it may be easier and more effective than reforming banker pay.
Regulatory failures during the crisis resulted at least in part from a lack of sufficient incentives for bank examiners to act aggressively to prevent excessive risk taking by banks. While banker pay may have been too high-powered—too focused on shareholder value and insufficiently sensitive to potential losses, which would ultimately be borne by taxpayers—bank regulators’ pay was not high-powered enough and therefore, ironically, also insufficiently sensitive to potential losses to taxpayers.
Bank regulators are not paid for performance. They are civil servants paid a fixed salary that does not depend on whether their actions improve banks’ performance, protect banks from failure, or increase social welfare. In fact, trying to curb risk taking at a bank may be personally very costly for a bank regulator. Without a larger upside than what civil service compensation offers, regulators too often do the rational thing and play it safe, shying away from confrontation over potentially ill-advised bank policies.
Read more at Regulation