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A proposal aims to curb the excessive risk-taking that could lead to financial crises.

Associated Press

WASHINGTON - The Federal Reserve for the first time would police banks' pay policies to make sure they don't encourage excessive risk taking under a plan the Fed is drafting.

The proposal is the Fed's latest response to criticism that it failed to crack down on lax lending, reckless gambles and other practices that led to the financial crisis.

The central bank's more activist stance carries a risk, though: It could intensify accusations from lawmakers and other critics that the Fed is overstepping its bounds and should be reined in.

The compensation issue is likely to surface when President Barack Obama meets with his counterparts from other major industrialized countries in Pittsburgh next week. French President Nicolas Sarkozy is leading a European attempt to rein in banker bonuses at the Group of 20 summit.

G-20 leaders promised at their London meeting in April to pass "tough new principles on pay and compensation." But little progress has been made.

Under its proposal, the Fed would review - and could reject - pay policies that could cause too much risk taking by executives or other employers, according to two people familiar with the plan. The Fed would not actually set compensation, however, said the people, who requested anonymity from the Associated Press.

Yet the proposal is far-reaching. The Fed would review salaries, bonuses and other compensation for CEOs and other senior management. It also would cover certain employees, such as traders, who can take big risks on behalf of a firm, they said. And it would cover some workers whose compensation could affect their risk-taking, such as loan officers making mortgages, they added.

The goal is to make sure banks' pay policies don't encourage top managers or other employees to take gambles that could endanger a company, the broader financial system or the economy. The failure of many banks to closely monitor risk and limit compensation that might encourage too much risk contributed to the financial crisis.

The proposal, in the works since early this year, could be unveiled within weeks, people familiar with the initiative said. The public, the industry and others would be able to comment on the proposal, which could be revised. A final plan, subject to approval by the Fed's Board of Governors, could be adopted by year's end.

Some details of the Fed plan were reported Friday by the Wall Street Journal.

According to the Journal, the proposal would cover all banks - nearly 6,000 of them - regulated by the Fed. It wouldn't cover savings and loans or other institutions overseen by the Federal Deposit Insurance Corp. or other regulators.

Because compensation plans can be structured in numerous ways, the Fed is avoiding a one-size-fits-all approach. The biggest banks - about 25 of them - would develop their own plans. If the Fed approves, the plan would be adopted and bank supervisors would monitor compliance, people familiar with the proposal said.

At smaller banks, where compensation is typically less, the Fed would provide guidance about what steps it thinks could rein in excessive risk-taking.