The Reserve Bank of India recently unveiled draft rules on compensation for CEOs and full-time directors of banks, for what it calls material risk-takers and those in charge of control functions. What is the objective of this move, and how does it mark a change from the past?
The way it was
Over a decade ago,a senior executive in one of India’s top private banks, until then considered a potential candidate for the top job in the bank, was identified as being responsible for the lender taking a hit of Rs 200 crore in a quarter. This was because of a wrong bet on a complex financial product, prompting the board to seek action. Although the executive was moved out a little later, his compensation was not impacted.
Two decades ago, another high-profile senior executive of the same bank was found to have taken calls in the debt market that led to a trading loss of over Rs 300 crore. In those days of relatively lax regulatory oversight and with influence at work, the executive was moved abroad and brought back after a cooling-off period. The person later went on to head one of India’s largest banks.
This contrasted glaringly with India’s state-owned banks, where executives have been punished by the government and the CBI for offences or violations that have been far less grave.
Getting away with dodgy deals may have been possible for private bank executives until a few years ago, but it will be difficult now given the greater scrutiny on rewards for the top deck. Increasingly, the field is being levelled between private and public sector banks, at least in terms of being punished for lapses. This started during the tenure of former RBI Governor Urjit Patel, under whose watch top private bank chiefs had to exit after major violations. The case involving ICICI CEO Chanda Kochhar who had to quit after allegations of conflict of interest, those of a couple of other bankers who had to leave after the RBI found a divergence in financial information or accounts from what their banks published, and the huge compensations paid to them over the past several years, appear to have been the trigger for the changes that are now under way.
India & the West
The latest move comes with the recent unveiling of the RBI’s draft rules. The aim is to ensure that rewards for senior executives in private and foreign banks are in sync or aligned with the risks undertaken by the banks. In other words, like in the West where the regulators and governments decided to discourage excessive risk-taking after the 2008 global financial crisis, the Indian central bank too is set to squeeze executive compensation. The first set of such rules has been in force since 2012. But much has changed since then, with the Financial Stability Board coming out in 2009 with a set of principles and implementation standards on compensation practices. India too is a member of the FSB. In the US, the Dodd Frank Wall Street reforms and Consumer Protection Act addresses this issue.
So, what’s new?
Topping the rules this time is the proposal that a substantial part of the compensation — at least 50% — should be variable. Earlier, there was no such threshold, implying that senior private bankers could take home a substantial amount irrespective of lapses or violations. Now that will be capped, subject to fulfilling laid out criteria. Similarly, stock options were not part of the variable pay component; that too will change now, as this form of reward will be part of a banker’s variable pay, which has been capped at 200% of the fixed pay. The lessons of the past — as in the approval of ultra-generous stock options granted to the CEOs of India’s private banks, sometimes even when the bank’s performance was poor — now seem to have been driven home. Private and foreign banks will also have to mandate clawbacks in cases of divergence of accounts, when it comes to setting aside funds against bad loans or identifying bad loans or negative contributions. Guaranteed bonuses are also out, with a cap proposed to be imposed on sign-on bonus, as the Indian regulator says it is not consistent with sound risk management or what it terms the “pay for performance” principles.
What remains to be done
One can expect grumbles from private bankers about how such fetters will put off so-called bright men or women, and how these will fail to attract them to work in these banks. What they forget, however, is that unlike manufacturing, there is a bigger risk of financial instability when it involves banks and the use of public funds.
While addressing this issue, the government has failed to address the asymmetry between India’s state-owned banks and private banks on compensation practices in the same industry segment. Even three decades after liberalisation, no government has been able to overcome the resistance from the bureaucracy to rewarding PSU bankers, with arguments such as how they cannot be paid more than the country’s top civil servant. It is a flawed argument, considering that the top civil servant’s job is to ensure high-quality governance and not to be measured on profitability metrics. Little wonder that many of them view state-owned banks as utilities. Not just that; India’s top private bank chiefs have the freedom to hire their own teams, unlike state-owned banks where the CEO has to settle for deputies chosen by the government.
The proposed new rules seek to rein in bankers, but there is little indication of how the regulator and the government plan to address the issue of failures of bank boards. In each of the private banks where the CEOs were either told to go or failed to secure approval for a fresh term, as well as at IL&FS that was run to the ground, the board of directors was complicit. The price for their failure is paid by shareholders. So far, most of them have got away without even a light rap on their knuckles. Ensuring accountability of such boards should be the next step.