As I mentioned earlier, the emphasis in compensation practices on short-term performance over longer-term sustainable returns was a key vulnerability revealed during the crisis that helped motivate imprudent behavior. Currently, senior bankers are paid mainly in cash and deferred stock grants. This structure creates incentives to take actions to maximize a bank’s share price, rather than to minimize the risk of the bank’s failure. While compensation practices today feature a larger deferred component, greater emphasis on deferral in the form of long-term debt—which can also be recognized as TLAC—could better align senior managers’ interests with the long-term safety and soundness of the firm.16 As I see it, this approach could have two benefits. For one, it would reduce the incentives for risk-taking. For another, if TLAC debt holdings were at risk of conversion to equity in the event of failure, I believe senior bankers would be incentivized to cut dividends or raise equity capital earlier to reduce the risk of failure. 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. 6/8  BIS central bankers' speeches  Some banks have experimented with such compensation schemes, and I would encourage more to do so. But, this type of reform may also need a push from the regulatory side. Banks may be reluctant to adopt such pay structures on their own for competitive reasons.
In contrast, a new U.S. Treasury repo reference rate will be based on actual transactions in a deep and liquid market, and is designed to be compliant with new principles set forth by the International Organization of Securities Commissions.7 In the foreign-exchange market, bad incentives helped encourage rate rigging at particular rate-fixing times. Reforms were subsequently introduced, including recommendations from the Financial Stability Board’s Report on Foreign Exchange Benchmarks and the recent publication of the FX Global Code, developed by central banks and market participants.8 The creation of millions of unauthorized accounts at Wells Fargo also reflected bad incentives. Bank employees were compensated on sales volume with aggressive crossselling targets without customers actually receiving beneficial services. In response, the Federal Reserve Board entered into a consent cease-and-desist order with Wells Fargo that requires the firm to improve its governance and risk management processes. These recent cases were particularly disturbing in terms of their scale and flagrancy, and—in the case of the rate-rigging scandals—the collusion by employees across firms. I am particularly struck by the fact that manipulation of the foreign exchange market occurred even after the LIBOR scandal was well known. These episodes underscore the tremendous power that incentives have to influence and distort behavior, potentially leading to massive damage to bank cultures, reputations, and finances.