Compensation to Whole Time Directors/Chief Executive Officers in private sector banks: RBI latest guidelines
It was an incidental meeting with one of the brilliant young economists from Commerce Ministry who enlightened me of her decision to try private sector jobs that are more challenging than the lucrative government jobs by acquiring higher qualifications. Yes, RBI vide its communication dated 4th November 2019 has given the guidelines on compensation to whole time directors/Chief Executive Officers of private sector banks/foreign banks operating in India. Perhaps, this is an attempt to throw a light on the pay scale of giant private sector banks executives who cast a long shadow on banking scene and get awards successively either by performance or vanish in the horizon effortlessly.
RBI vide RBI/2019-20 DOR.Appt.BC.No.23/29.67.001/2019-20 dated November 4, 2019 narrates its story to be firmly followed by all.
Due to financial crisis in 2008/2009, which shook the existence of many big banks in USA and elsewhere, Financial Stability Board (FSB) of USA brought out a set of principles and implementation standards that would envisage effective governance compensation, its alignment with prudent risk taking and effective supervisory oversight /stakeholder engagement. Blindly copying these guidelines, RBI brought about its exhaustive guidelines for top executives in private sector banks. Disaster struck Indian private sector banks and its executives who violated the sacred trust of all their stakeholders resulting in removal of many CEOs from many banks and its refusal for extension to a few. My presumption is that the above also contributed towards new guidelines.
I would like to educate ourselves the narration of RBI guidelines. I presume that the current guidelines would ensure a sacred motive for private sector banks and its executives for excellence from 2020 onwards.
Let us learn from the master, FSB, the basics.
The principles of Sound Compensation Practices are as under:
- Effective governance of compensation – The Board of Directors to oversee compensation system’s design and operation, monitor the compensation system, and staff engaged in financial and risk control must be independent and compensated irrespective of the areas supervised by them. All in altruistic sense.
- Effective alignment of compensation with prudent (acting in a cautious and sensible way) risk taking – in a simple man’s dharma, higher risk with disastrous consequences would result in terrible loss of money, equity or other forms of compensation.
- Obviously, supervisory oversight and engagement by stakeholders – supervisory review to remain independent, rigorous and timely action to be taken on actual experience and inform to all stakeholders on timely basis.
RBI on its page 5 sets the tone for compensation for Private Sector banks and Foreign banks. A caveat is issued with the implication that private sector banks include Local Area Banks, Small Finance Banks and Payments banks. Foreign banks are required to conform basing their pay structure of their executives on FSBs principles and standards.
Effective governance of compensation:
1. Compensation Policy – Banks are expected to form a comprehensive compensation policy and proper review on an annual basis.
2. To the varied question on compensation structure, the list incorporates fixed pay, perquisites, performance bonus, guaranteed bonus (joining/sign in bonus), severance package, pension and gratuity, employee stock option plan, etc.
3. To nominate a ‘Nomination and Remuneration Committee’ of the Board to framing, oversee the review, and implementation of compensation policy. NRC to have a committee of members half of whom would be independent directors. Expectedly NRC to work in close association with Risk Management Committee.
Effective alignment of compensation with prudent risk taking:
For whole time directors/CEOs/Material Risk Takers banks to ensure that
1. Compensation is adjusted for all types of risks
2. The compensation outcomes are symmetric with risk outcomes
3. The compensation payouts are sensitive to the time horizon of the risks and
4. The mix of cash, equity and other forms of compensation are consistent with risk alignment.
5. Some of the measures of credit, market, liquidity and various other types of risks may be used by banks in implementation of risk adjustment.
Fixed pay and Perquisites
Fixed pay to be on a reasonable scale to include perquisites with contributions towards superannuation/retiral benefits.
Limit on Variable Pay
It is amply provided that proper balance between fixed pay and variable pay be maintained. 50% of pay to be paid on variable basis of performance of individual/business unit/firm-wide measures.
I have actually reproduced from the actual wording to spell out the true essence of RBI guidelines. In view of recent spill over from private banks’ balance sheets whose tremors are being still felt by all stake holders, this action has been done.
1. “At higher levels of responsibility, the proportion of variable pay should be higher. The total variable pay shall be limited to a maximum of 300% of the fixed pay (for the relative performance measurement period).
2. In case variable pay is up to 200% of the fixed pay, a minimum of 50% of the variable pay; and in case variable pay is above 200%, a minimum of 67% of the variable pay should be via non-cash instruments.
3. In the event that an executive is barred by statute or regulation from grant of share linked instruments, his/her variable pay will be capped at 150% of the fixed pay, but shall not be less than 50% of the fixed pay.”
Interestingly, it has been provided that financial performance of the bank must generally lead to a contraction in the total amount of variable compensation, which can even be reduced to zero.
What about deferral pay?
Guidelines prohibit deferral requirements for variable pay under Rs 25 lacs. For others, a minimum of 60% of variable pay must be in deferral arrangements. The minimum period of deferral is a minimum of 3 years. Since assessment of risk is inherent in release of deferral payments, release of the same has been on the conservative basis.
It is very important that adequate disclosure about deferral payments to executives has been made mandatory. ‘Malus’ clause ensures adequate protection in case of NPAs exceeding the public threshold for disclosure. Increase in variable pay will not be allowed in that year.
Guaranteed bonus is not consistent with sound risk management principle or pay for performance principles. Invariably, it is reserved for new recruits and that too in the form of share-linked instruments.
Relevant guidelines do not allow hedging of compensation structure to offset the risk alignment effects incorporated in their compensation arrangement.
Guidelines for Risk control, internal audit or compliance staff
Some one experienced in modern banking enquired whether staff from financial, risk control, internal audit or back office will be controlled by unbridled guidelines which limit variable pay. Some of them may be involved in overseeing business areas too. If only the staff connected to high flying Nirav Modi or any other fraudsters were given the required freedom or enabled independence to say ‘no’ at relevant time, Punjab National Bank with 125 years of unblemished business dealings would not have suffered loss of historic proportions.
Even today, a reported fraud of Rs 7000 crores in” who is who” banking system portends a bleak picture of the current banking scene which looks like post world war Hollywood film of loot in banks. Unfortunately, my curiosity as an experienced banker of 3 decades always believed that top ranking Indian public sector banks have evolved world class risk and compliance standards, review systems or adequate punishment results for corrupt officials.
Next Material Risk Takers of banks
Either “X” from England or “y” from India have contributed total chaos and resultant huge loss to commercial banks. History, unfortunately repeats and bears testimony for huge losses for a common man who believes in the historic banking systems and procedures.
What can or should be done to avoid repeat of historic blunders in banks?
It is essential to identify material risk takers (a fanciful name with the notation that one who can cause collapse of banking systems and loot) who can cause significant risk exposures to banks. Names of foreign exchange currency dealer who made notoriety with the biggest Irish bank loss or the rogue who enabled PNB and other banks on total collapse of their 125 years of successful existence with simple issue of repeat banking instruments of regular commitments of pay on no basis. Yes, a simple system which looted the bank nearly Rs 14000 crores though it managed to recover substantial amounts during the last two years.
But in a private bank, even if the total remuneration exceeds a certain threshold or those among 0.3% of staff with the highest remuneration. Bankers in India have been having a cut off beyond which only the Board could take the risk. But in reality, it seems to have vanished.
Reporting system
Appendix 1 contains the following information:
Details of remuneration/compensation of whole-time directors/chief executive officer:
- Part A with details of fixed pay with perquisites which include free furnished house with its maintenance or house rent allowance, conveyance allowance or free use of bank car for official/personal use, driver’s salary, club membership, reimbursement of medical expenses or any other benefits.
- Part B with varied pay with details of cash component, vesting periods, non- cash component like ESOP/ESOS, any other share linked instruments.
- Details of cash component in varied pay, % of non -cash component in total variable pay, % of variable pay to fixed pay or % of variable pay in total compensation.
Appendix 2 narrates the methodologies for risk and performance of remuneration.
Conclusion
Every- one agrees that in spite of detailed guidelines issued or copied from Western world, India has failed to save the common depositor, its shareholders or the evanescent government for historical reasons. But we hear corruption as a hallowed sound with all the transactions that emanate in private or public sector banks. Intentionally, I wrote about RBI guidelines on private sector banks which have also fallen into the dishonorable deeds and resultant loss to all concerned without any remorse. Continuous removal of most celebrated CEOs of private sector banks or charge sheet or arrest of public sector top executives with resultant bail, shook my conscience. If a cursory glance of this article or deep study of RBI guidelines based on FSB standards may shake the conscience of Board of Directors or embrace the top managements to strictly follow the established rules and report them to all stake holders, my purpose has been achieved.
If not as an experienced and retired banker with unblemished record, but as a poor shareholder if the banks return to their known fields of integrity and honesty, the purpose of writing this article will also be fulfilled. Let us hope wiser wisdom will prevail in banking system.
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