The Reserve Bank of India (RBI) on Monday said chief executives of banks should have at least half of their pay based on performance, as the regulator tries to tweak incentives to prevent the reckless risk-taking that has burdened India’s lenders with record bad loans.
Employees, RBI said, were often rewarded for increasing short-term profit without adequate recognition of the risks and long-term consequences that their activities posed to the organizations. Misaligned compensation practices, especially of large financial institutions, were among the important factors that contributed to the global financial crisis in 2008, the regulator said.
“These perverse incentives amplified excessive risk taking that severely threatened the global financial system. The compensation issue has, therefore, been at the centre stage of regulatory reforms," it said.
This is part of RBI’s guidelines on compensation of whole-time directors, chief executive officers, material risk takers and control function staff released on Monday.
“It should be ensured that there is a proper balance between fixed pay and variable pay. In accordance with FSB Implementation Standards, a substantial proportion of compensation i.e., at least 50%, should be variable and paid on the basis of individual, business-unit and firm-wide measures that adequately measure performance," said RBI.
The total variable pay, RBI said, shall be limited to a maximum of 300% of the fixed pay. Moreover, 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.
These guidelines will be applicable for pay cycles beginning from and after 1 April 2020. The guidelines are applicable to private sector banks, including local area banks, small finance banks and payments banks. They are also applicable to foreign banks operating in a wholly-owned subsidiary structure.
The central bank also said that for senior executives, including whole-time directors, and other employees who are major risk takers, deferral arrangements must invariably exist for the variable pay, regardless of the quantum of pay. For such executives of the bank, RBI said, a minimum of 60% of the total variable pay must be under deferral arrangements.
RBI said the deferred compensation should be subject to clawback arrangements in case of subdued or negative financial performance of the bank.