Monday, July 19, 2010

Regulating Bankers’ Pay

Consistent with international trends to impose greater regulation on executive compensation in banks, the Reserve Bank of India (RBI) has issued draft guidelines on compensation of whole time directors/ chief executive officers / risk takers and control function staff. This applies to private sector and local area banks and all foreign banks operating in India, and is in addition to tight controls that already operate with respect to public sector banks.

The preamble contains the rationale:
Flawed incentive compensation practices in the financial sector were one of the important factors contributing to the recent global financial crisis. Employees were too often rewarded for increasing the short-term profit without adequate recognition of the risks the employees’ activities posed to the organizations. These perverse incentives amplified the excessive risk taking that severely threatened the global financial system. The compensation issue has, therefore, been at the centrestage of the regulatory reforms. To address the issues in a coordinated manner across jurisdictions, the Financial Stability Board (FSB) has brought out a set of principles and implementation standards on sound compensation practices in April and September 2009, respectively. The principles are intended to reduce incentives towards excessive risk taking that may arise from the structure of compensation schemes. The principles call for effective governance of compensation and its alignment with prudent risk taking and effective supervisory oversight and stakeholder engagement. The principles have been endorsed by the G-20 countries and the Basel Committee on Banking Supervision (BCBS) and are under implementation across jurisdictions.
The draft guidelines adopt the FSB Principles for Sound Compensation Practices. They call for determination of compensation on the basis of long-term performance parameters, for the establishment of remuneration committees on banks, and even for a claw-back provision (that is fairly novel in the Indian context). Comments are due on the draft guidelines by July 31, 2010.

For a discussion on the policy among banking experts, please see India Knowledge@Wharton.

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