Small banks must start offering incentive plans if they want to attract and keep outstanding personnel, says Dale Arahood, a Wheaton, Ill.-based consultant.

Right now, he says, only 20% of the nation's small banks have effective, performance-based incentive plans.

The others either rely on pointless bonuses - such as hams for all employees at holiday time - or have no reward systems at all.

Mr. Arahood offers some model plans in a book he recently wrote for the American Bankers Association, "Community Bank Incentive Compensation Plans."

Mr. Arahood, a former partner in what is now Deloitte & Touche, is president of Incentive Compensation Publications. He argues that the issue of incentive pay has become crucial to the ability of small banks to compete.

"Many nonbank firms are jumping into banking, and the smaller banks generally aren't in a strong position to put big salaries on the table," he says.

Incentive plans can go a long way in addressing this problem-but many community banks are discouraged by the costs of devising and implementing such a program.

Thus, most seek a simpler way to wring the best performance out of employees, says Ed Rogers, a managing partner of the Penicle Group, a Houston human resources consulting firm.

Formal Planning Required

Some small banks, for example, will try to make their employees loyal and hardworking by encouraging participation in a stock ownership plan.

But effective incentive plans require formal planning and a sophisticated financial system that enables you to monitor and measure results," Mr. Rogers said.

"A lot of small banks don't have that level of sophistication, and they don't have the time or staff to monitor everyone's performance."

So, these institutions might want to use an overall measure of bank performance, like return on equity or assets, and apportion bonuses to employees on the basis of how much the bank exceeds peer performance, Mr. Arahood said.

Incentives for Top People

Washington consultant Edward Furash says the directors of banks with less than than $250 million in assets know that incentives are important at the sales side, "but they still don't appear to be particularly interested in big-time incentives for top management."

Maybe so, but the top people should be incentived and they should be incentived first," Mr. Arahood said.

He added that bonuses at this level should relate to the bank's performance in achieving its growth and asset liability management goals.

If the bank is publicly held, senior management bonuses also should be tied to gains in such shareholder values as stock price and dividends, Mr. Arahood added.

Hard to Gauge

"Since your controller, your auditor, and your marketing people will all support your growth and asset liability management plans, their performance in those areas should be part of their incentive package," he said.

However, measuring performance is often much more difficult. How, for example, do you evaluate loan officers?

"Lending is a tough one," Mr. Arahood said. "Regulators frown on [lending] volume rewards, so incentives for your officers should be based on spreads and yields and their management of past-due loans.

"A subjective evaluation is also possible," Mr. Arahood added. "Try to gauge if your officer is' with the program' or not."

The "program," Mr. Arahood explained, might be an overall effort to step up Community Reinvestment Act lending or a cross-selling initiative.

Evaluating platform staff also takes "a lot of work, and there's a possibility of dishonesty out in the branches."

Cheating could take the form of exaggerations, or worse, on employee performance reports, so "you need somebody to keep and audit [performance] records and pay that person a percentage of what everyone earns."

Mr. Rogers of Penicle expects more small banks to start considering incentive plans over the long term, but he advises community bankers to prepare very carefully before implementing such plans.

"The worst thing you can do is establish an incentive plan and have it fail," he said, "because then what you're left with is a demotivated work force."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.