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Fed's Dudley: Heavier penalties for bank officials may lessen financial risks

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Fed's Dudley: Heavier penalties for bank officials may lessen financial risks

Top officials at financial institutions should face heavier penalties if regulators find wrongdoing in their operations, Federal Reserve Bank of New York President William Dudley said March 26, adding that the stricter approach may decrease risks to the financial system.

Dudley, speaking at a U.S. Chamber of Commerce event in Washington, D.C., largely praised the financial regulatory framework that arose after the financial crisis but said there are more steps bank regulators and industry leaders should take.

"I think we're making progress," he said. "I think what I worry about is declaring victory prematurely."

One possible option, he said in prepared remarks, is boosting regulatory and legal penalties for senior company managers who would then have a more "powerful incentive to promote better behavior" from employees.

To a large extent, he said, the culture shifts inside companies to avoid excessive risk-taking are already happening. Still, he said, top bankers get much of their compensation through bonuses that lead them to focus on maximizing share prices, a short-term focus that minimizes long-term stability concerns. He listed the scandal over phony account openings at Wells Fargo & Co. as just one example of the issue.

Bank leaders, he said, should instead be compensated more on deferral of long-term debt, a move that may lead them to cut dividends or raise money earlier on to lessen the risks of financial turmoil. Dudley said that is key because the current system, while it has improved capital buffers for institutions, "may not be sufficient" to ensure banks have a big enough cushion heading into the next downturn.

"Having a regime in place that creates strong incentives for management to steer aggressively away from bad outcomes would be better than one in which management has incentives to temporize in the face of rising risks," Dudley said.

Some banks have already tried adopting a switch in their compensation, Dudley said. But he recognized that the effort "may need a push from the regulatory side" since others may avoid adopting a new compensation structure over fears that top talent might avoid applying to their firms.

Dudley, who is leaving his role this year, also said efforts to revisit financial regulations a decade after the crisis are important. Randal Quarles, the Fed's vice chairman for supervision, has been examining ways for the Fed to make its regulations more efficient, while Congress is debating a proposal to increase the asset threshold for banks who face enhanced prudential standards.

Dudley said the bill that the Senate passed this month generally "goes in the right direction" by easing some burdens on smaller banks yet keeping in place the key pillars of the Dodd-Frank law.