Bernanke on banks: Pay 'close attention' to compensation

PHOENIX -- Federal Reserve Chairman Ben Bernanke on Friday called for banking supervisors to pay "close attention" to compensation practices as they examine the soundness of financial institutions.

Banking regulators have observed that "poorly designed compensation policies can create perverse incentives that can ultimately jeopardize the health of the banking organization," Bernanke told a meeting of smaller "community" banks.

The Fed chief's remarks come amid public and congressional outrage over millions of dollars in bonuses paid to employees of American International Group, which has been bailed out by the government four times. The situation has created a public relations headache for President Barack Obama and unleashed fresh congressional furor over the handling of AIG's bailout by the Treasury Department and the Fed.

Bernanke, who will appear before Congress on the AIG flap next week, didn't mention any companies by name in his speech. He made a fresh pitch for an overhaul of banking regulations to prevent another financial crisis like the one gripping the U.S. and other countries worldwide.

Regulatory gaps need to be closed, he said. Regulators must make sure financial companies have a sufficient capital cushion against potential losses.

And Congress must enact legislation so that the failure of a huge financial institution can be handled in such a way to minimize fallout to the national economy — similar to how the Federal Deposit Insurance Corp. deals with bank failures. Such "too big to fail" companies must be subject to more rigorous supervision to prevent them from taking excessive risk, Bernanke said.

Obama said Wednesday his administration soon will propose new financial industry oversight that includes a resolution authority with powers similar to those of the FDIC, which can seize control of banks, take over their bad assets and sell the good ones to competitors.

The proposal would give the Treasury secretary the power, after consulting with officials at the Fed, to take control of a major financial institution and run it. The Treasury chief is an official of the administration, unlike the FDIC, which is an independent regulatory agency.