RBI sets terms on bank chiefs’ pay

In a clear attempt at transparency, the Reserve Bank of India (RBI) on Friday came out with guidelines on compensation of wholetime directors, chief executive officers and other risk takers in private and foreign banks.

In an announcement on its website, the central bank made it very clear that one of the major reasons for the recent global financial crisis was the compensation practices in major financial institutions.

From now, private sector and foreign banks are required to obtain regulatory approvals for remuneration of CEOs and wholetime directors.

While bank boards are required to oversee and review CEO compensation, pay packages are to be linked to the risks involved with the position and must be reviewed annually, RBI directed.

It has asked private banks to set up a remuneration committee for this. The committee will consist of three members and an additional member from the risk management committee of the board of directors.

“The remuneration committee should also ensure that the cost/income ratio of the bank supports the remuneration package consistent with maintenance of sound capital adequacy ratio,” the banking regulator said in the announcement.

The central bank urges private sector banks to ensure that the fixed-pay component in the remuneration for these executives is reasonable, taking into account industry practices.

Banks have to also ensure that the variable component of their package does not exceed 70% of fixed pay. Within this ceiling, however, variable pay should be higher at positions of greater responsibility.

“It is an attempt to link pay to performance and provide risk-adjusted returns. This way, executive compensation will result in long-term wealth creation and shall also provide reward to shareholders,” said E Balaji, managing director and CEO of MaFoi Randstad, an executive search firm.

“Members of staff engaged in financial and risk control should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank,” the announcement said.

The RBI said maintaining the independence and appropriate authority of risk control officials is important to preserve their
influence on incentive compensation.

“It is a welcome move as it will encourage more responsibilities, better performance and transparency. In the financial system, this will be better for all stakeholders and employees,” said Anish Laikar, CEO, Selectema Consulting, a search and recruitment firm based in Mumbai.

The RBI has also asked these banks to make disclosures regarding compensation at least on an annual basis, in their annual financial statements. Private sector and foreign banks have been asked to finish framing these policies by March 31 and must implement them in the next financial year.

The draft guidelines for compensation policies were put up on the central bank’s website in July 2010 and on the basis of the responses received, the final guidelines were to come out by end-December 2010.

However, in February 2011, RBI announced that it had deferred the announcement of these guidelines till 2012-13, thereby giving time for banks to adapt to the draft suggestions.