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To tackle NPA under-reporting and misconduct, RBI asks private banks to set clawback mechanism

Sets norms on compensation of whole-time directors, CEOs

By: ENS Economic Bureau | Mumbai |
November 5, 2019 1:08:42 am
 RBI, RBI NPA, RBI NPA data, NPA reporting RBI, RBI News, Indian express business news The banks should identify a representative set of situations in their compensation policies, which require them to invoke the malus and clawback clauses that may be applicable on entire variable pay, RBI said.

The Reserve Bank of India (RBI) has tightened the guidelines for compensation packages of whole-time directors (WTDs) and chief executive officers (CEOs) of private and foreign banks, and asked them to put in place a clawback mechanism to address the misconduct risk and under-reporting of bad loans.

In its guidelines on compensation of WTDs and CEOs of banks, the RBI said, “Wherever the assessed divergence in bank’s provisioning for non-performing assets (NPAs) or asset classification exceeds the prescribed threshold for public disclosure, the bank should not pay the unvested portion of the variable compensation for the assessment year under ‘malus’ clause.” Several private banks had reported governance issues and suppressed non-performing assets (NPAs) to artificially show better performance, even as their CEOs got higher pay packages year after year.

“Further, in such situations, no proposal for increase in variable pay (for the assessment year) should be entertained. In case the bank’s post-assessment gross NPAs are less than 2.0 per cent, these restrictions will apply only if criteria for public disclosure are triggered either on account of divergence in provisioning or both provisioning and asset classification,” the central bank said.

The banks should identify a representative set of situations in their compensation policies, which require them to invoke the malus and clawback clauses that may be applicable on entire variable pay, it added.

The RBI also said guaranteed bonus is not consistent with sound risk management or the ‘pay for performance’ principles and should not be part of the compensation plan. “Therefore, guaranteed bonus should only occur in the context of hiring new staff as joining/sign-on bonus and be limited to the first year,” it added.

The banking regulator said a substantial proportion of compensation — at least 50 per cent — should be variable and paid on the basis of individual, business-unit and firm-wide measures that adequately measure performance. At higher levels of responsibility, the proportion of variable pay should be higher, it said.

“The total variable pay should be limited to a maximum of 300 per cent of the fixed pay (for the relative performance measurement period). In case variable pay is up to 200 per cent of the fixed pay, a minimum of 50 per cent of the variable pay; and in case variable pay is above 200 per cent, a minimum of 67 per cent of the variable pay should be via non-cash instruments,” the RBI said.

In the event that an executive is barred by statute or regulation from grant of sharelinked instruments, his/her variable pay will be capped at 150 per cent of the fixed pay, but should not be less than 50 per cent of the fixed pay, it added.

The deterioration in the financial performance of the bank should generally lead to a contraction in the total amount of variable compensation, which can even be reduced to zero, the RBI said.

For senior executives, including WTDs and other employees who are MRTs (material risk takers), deferral arrangements must invariably exist for the variable pay, regardless of the quantum of pay. For such executives of a bank, a minimum of 60 per cent of the total variable pay must invariably be under deferral arrangements. Further, if cash component is part of variable pay, at least 50 per cent of the cash bonus should also be deferred, the RBI said. However, in cases where the cash component of variable pay is under Rs 25 lakh, deferral requirements would not be necessary, it said.

A malus arrangement permits the bank to prevent vesting of all or part of the amount of a deferred remuneration. A clawback, on the other hand, is a contractual agreement between the employee and the bank in which the employee agrees to return previously paid or vested remuneration to the bank under certain circumstances. “When setting criteria for the application of malus and clawback, banks should also specify a period during which malus and/or clawback can be applied, covering at least deferral and retention periods,” the RBI said.

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