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Banker Salaries: Is RBI Being Prudent Or Prescriptive?

BloombergQuintOpinion

The Reserve Bank of India’s proposal to review compensation structures followed across private sector banks is bound to generate debate.

The believers will see this as an attempt to align risk-reward structures in Indian banking to those followed globally and to quell some of the excessive risk-taking seen over the last lending cycle. Non-believers will see it as micro management and argue that it will subdue the risk-taking spirits needed to take private banks to the next level in a developing economy like India.

Truth is that the RBI’s new proposals will do a little bit of both.

Also read: RBI Proposes Revamp Of Bank CEO Compensation

Compensation Structures: Global vs India

Following the experience of the global financial crisis, the Financial Stability Board was tasked with reviewing global best practices for compensation of bank executives. The review led to the establishment of ‘Principles and Standards of Sound Compensation’ in 2009. These principles were later endorsed by the Basel Committee On Banking Supervision.

These principles were based on two pillars:

  • The first pillar is of corporate governance. This includes ensuring the independence and accountability of the compensation systems. It also seeks to ensure that risk management systems are independent and not aligned to the interests of specific parties.
  • The second pillar is that of compensation. Here the rules say that compensation should be aligned to the executive’s contribution to risk taken on by the bank. That this compensation should be conditional on performance and risk outcomes. That there should be adequate time given to assess the risk outcomes. And that the compensation should be a mix of cash and equity.

It is the second of these pillar that the RBI has kept in mind while framing its latest discussion paper on compensation of top executives at banks.

It has asked that at least 50 percent of a bank CEO’s compensation be variable. And that 50 percent of that variable pay be in the form of stock. This is understandable because CEO performance then gets linked back to the performance of the bank. With the same principle in mind, the RBI has proposed to put a stop to guaranteed bonuses.

Where the RBI has gone a step further is in prescribing a cap on the variable pay in relation to the fixed pay, In its discussion paper, it said that variable pay cannot be more than 200 percent of the fixed pay. But this variable pay will also count employee stock options, which, according to the earlier rules, were not considered part of the variable component.

This will become the nub of the debate and questions will be asked about whether the rules are unnecessarily prescriptive.

Also remember, that in India, banks have to get RBI to sign-off on the compensation package of individual bank CEOs. So, in essence, the regulator controls the absolute compensation, including ESOPs, by controlling the fixed pay and capping the variable pay in relation to that. That may be precisely what the RBI wanted to do but it will be debated.

Some believe there is overreach in this approach because, in an ideal world, this job should be done by bank boards. But perhaps the recent experience with board governance, particularly at some large private banks, left the regulator skeptical.

Also read: How Salary Structures Of Top Bankers May Change With RBI’s New Rules

India-Specific Tweaks

Contextually, the more important part of the RBI’s proposals is the suggestion that penalties be imposed linked to asset quality divergence.

Once again, the principle behind that proposal is similar to what is followed globally. Banking is a business where risk in business decisions becomes apparent over many years. As such, there must be some mechanisms in place to ensure accountability of decision making over a period of time. Most banks already have provisions for claw-backs and penalties in place.

But given the experience of the last bad loan cycle, the RBI has spelled out a specific trigger for claw-back.

“Wherever the assessed divergence in bank’s asset classification or provisioning from the RBI norms exceeds the prescribed threshold for public disclosure, the bank shall not pay the unvested portion of the variable compensation for the assessment year under ‘malus’ clause. Further, in such situations, no proposal for increase in variable pay (for the assessment year) shall be entertained,” said the regulator.

While some will argue that this is excessive, it is not.

Until 2017, Indian lenders, including private sector banks, didn’t blink an eyelid if there was a divergence in asset classification.

The divergence was disclosed in a confidential report and there was no public disclosure of any action taken against those responsible. In 2017, the RBI told banks to disclose this divergence. But even then it was investors that paid the price for it. Now, the RBI is finally putting in a mechanism to penalise those who are eventually responsible for this divergence - bank CEOs.

In a few years, this provision may become redundant if banks are more stringent with compliance. But till end, it is essential and welcome.

Apart from penalties imposed on account on divergence, the RBI gives banks freedom to set their own set of triggers for claw-backs and penalties.

The Remaining 70%

Finally, it must be said that debating private bank salaries and compensation rules is only 30 percent of the debate. The bigger debate the Indian banking sector needs to have is about compensation at public sector banks. There, the issue is not salaries that are too high but salaries that are too low.

Those low salaries present their own risks to the banking sector which are as grave as the risks presented by excessively high salaries. Do low salaries leave bankers susceptible to temptation towards corruption? On the flip side, do they induce lazy banking? That is the broader debate we should be having. Of course, that debate is not within the purview of the RBI. It the responsbility of the government.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.