Bonuses linked to investment risk taking paid to bank employees contributed to the global financial crisis, officials told a special US commission examining the economic calamity.
They called for a review on the role of employee compensation and its contribution to risk taken by financial institutions, some of which collapsed after incurring massive losses on particularly mortgage-based securities.
"The crisis has shown that most financial institution compensation systems were not properly linked to risk management," said Sheila Bair, chairman of Federal Deposit Insurance Corporation, which insures depositors against bank failures.
"Formula-driven compensation allows high short-term profits to be translated into generous bonus payments, without regard to any longer-term risks," she told a congressionally mandated commission, which on Wednesday launched a probe on the crisis.
The crisis triggered by an American home mortgage meltdown sent a financial tsunami across the globe, slamming the brakes on growth and plunging the United States and many other nations into the worst recession in decades.
Bair said many derivative products, including mortgage securities which suffered hundreds of billions of dollars in losses, were "long-dated, while employees' compensation was weighted toward near-term results."
"These short-term incentives magnified risk-taking," Bair said.
SEC chairman Mary Schapiro told the hearing that a key "lesson learned from the crisis was that "there can be a direct relationship between compensation arrangements and corporate risk taking.
"Many major financial institutions created asymmetric compensation packages that paid employees enormous sums for short-term success, even if these same decisions result in significant long-term losses or failure for investors and taxpayers," she said.
Major US banks have come under criticism from President Barack Obama's administration and social groups over their plans to announce annual bonuses for top executives even as the nation struggled to recover from recession.
The Obama administration warned that any hefty payouts could lead to a political backlash as many of the banks which have recovered from the crisis had received injections of billions of dollars of public money.
Most of the planned payouts by banks however are likely to be in the form of stock, with restrictions aimed at discouraging excessive risk-taking at many banks.
The 10-member commission studying the crisis has been compared to the 9/11 panel that studied the September 11, 2001 terror attacks on the United States.
