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Some bankers reacted warily to news the Federal Reserve may review pay policies for thousands of bank employees.

"When does it stop?" asked Chevis Swetman, president and chief executive of the The Peoples Bank in Biloxi, Miss. "The government is running the car industry. Now do they want to run the bank?"

(This story and related background material will be available on The Wall Street Journal Web site, WSJ.com.)

Fed scrutiny of pay policies would be intended to intercept and prevent compensation practices that encourage bank employees - ranging from chief executives to traders to loan officers - from taking too much risk. Critics such as Paul Volcker, the former Fed chairman, say short-term compensation arrangements led banks to take on too much long-term risk and directly contributed to the financial crisis.

A final proposal is still a few weeks from completion, The Wall Street Journal reported. The 25 largest banks would face particularly close scrutiny.

The review of bank pay could encourage such compensation policies as "clawbacks," which would recoup pay based on profits that turned out to be illusory. Moreover, compensation in the form of shares, which would suffer if a bank ran into trouble, could also be encouraged by the Fed.

Some bankers, such as Peoples Bank's Swetman, expressed frustration at the possibility of new powers for the Fed, even if the intensified oversight wouldn't actually result in big changes to their institutions' pay practices.

"What good is another agency looking over what I am paid?" he asked.

Peoples Bank, with $890 million in assets, has not accepted U.S. bailout funds and already ties compensation to performance, Swetman said, with the CEO's bonus dropping from $59,577 in 2007 to $30,375 in 2008. He does not expect to take any bonus for 2009.

He predicts the Fed plan, if implemented, will harm the industry's ability to attract talented employees.

Edward Wehmer, chief executive of Wintrust Financial Corp. (WTFC), in Lake Forest, Ill., said compensation oversight will give regulators "another opportunity to have someone come in and tell us how to run our business...It's opening Pandora's box."

Wintrust, with about $11.3 billion in assets and 79 branches in Illinois and Wisconsin, received $250 million through the Treasury Department's Troubled Asset Relief Program. Wehmer said Wintrust already has changed its compensation practices to comply with the terms of receiving those taxpayer funds, such as including clawback provisions in its employment contracts.

"I get a little bit nervous with the idea that government agencies try to regulate what is and what is not in a company’s long term interest," said Robert Wilmers, the Chairman and CEO of M&T Bank Corp. (MTB) in Buffalo, N.Y. "They don’t always do what's in the country's long-term interest.

Wilmers, whose bank has $70 billion in assets and received $600 million in TARP funds, expressed concern that the "shadow" banking industry - that is, non-bank providers of credit - apparently isn't being addressed by the new rules. "The shadow banking industry accounted for most of the risk and most of the problems that led to the financial meltdown," he said. "The vast majority of Main Street banks, like M&T, had nothing to do with those risky financial derivatives and credit default swaps, and I think the best thing the regulators can do is get the shadow banking industry under control."

To be sure, some bankers applauded the Fed's move to oversee compensation and said it wouldn't affect banks with prudent pay practices.

"I like it," said Steve Steinour, chief executive officer of Huntington Bancshares Inc. (HBAN), a Columbus, Ohio-based bank that on Friday announced it had raised $400 million in a stock offering. "Having disciplined pay practices is good for the country long term. I do believe people should be paid with a view of how much risk they're taking," he said.

Huntington, which received $1.4 billion of TARP funds and lost money in the second quarter, is hoping to use the fresh capital to "play offense," Steinour said.

Robert Jones, CEO of Old National Bancorp (ONB), said the potential new Fed power "probably has a minimal impact on the vast majority of the banks." The Evansville, Ind., bank, with $7.8 billion in assets, relies on restricted stock for much of its long-term incentive pay and gives its board's risk committee a say in compensation decisions. (Old National received $100 million in TARP funds, which it repaid in March.)

Jones said a greater Fed oversight role will help rein in reckless behavior among the nation's biggest banks.

Jonathan Macey, a professor at Yale Law School, says the Federal Reserve plan "responds to an acute problem" of taxpayers losing when a bank blows up, but ceding all the gains to traders and executives when the bank makes a profit.

The proposal could have unintended consequences, however, he said. If the Fed takes the 25 biggest banks and works to make sure they are consistent in the way they pay people, it "may make things worse because it contributes to lemming-like, herd behavior," he said. "Bubbles are caused by that behavior. What you want is diversity and heterogeneity between firms."

Some on Main Street, such as Dan Smith of Norwood, Mass., were in favor of the proposed policies. "I think it's a good idea," the 63-year-old semi-retired software engineer said. "The system as it's presently set up rewards people for taking on crazy risks. If they have a good year, they get a bonus. If they have a bad year, nothing happens."

But Tom Corley, 48, a small-business owner in Rahway, N.J., is opposed to the potential new Fed powers. "My feeling is if the government is going to get involved in any way, shape or form in dictating compensation, I'm opposed to it."

-By David Enrich and Dan Fitzpatrick, The Wall Street Journal; david.enrich@wsj.com

(Aaron Lucchetti, Robin Sidel, Jane J. Kim and Matthias Rieker contributed to this article.)