RBI Guidelines for Bank CEO Compensation provides for clawback, and deferred payouts of variable pay.
Revised Guidelines for CEO, WTD Compensation
RBI, has announced a fresh set of guidelines for compensation of CEO’s, whole time directors (WTD’s) of Banks. These guidelines are based on a review of guidelines issued in 2012 (for implementation effective FY 12-13). They are also aligned with Financial Stability Board (FSB) Principles and Implementation Standards for Sound Compensation Practices and the Supplementary Guidance issued by FSB in March 2018 on the use of compensation tools to address misconduct risk. These guidelines issued on 4th November 2019, are applicable for pay cycles starting from 1st April 2020.
The background to the compensation guidelines – has been some of the factors that contributed to global financial crisis of 2008 – key employees being rewarded for increasing short term profit without adequate consideration of risk and without due regard to long term consequences of decisions and actions. Prioritizing short term gains increased has a potential of negatively impacting the concerned bank as well as the overall financial system.
The guidelines are applicable to private sector banks, including Local Area Banks, Small Finance Banks and Payments Banks, and foreign banks operating under the Wholly Owned Subsidiary mode (WOS), and foreign banks operating in India under the branch mode.
The RBI guidelines stipulate that – “Banks should continue to formulate and adopt a comprehensive compensation policy covering all their employees and conduct annual review thereof.The policy should cover all aspects of the compensation structure such as fixed pay, perquisites, performance bonus, guaranteed bonus (joining/sign-on bonus), severance package, share-linked instruments e.g. Employee Stock Option Plan (ESOPs), pension plan, gratuity, etc., taking into account these Guidelines.”
Fixed Pay and Perquisites
Banks are required to ensure that the fixed portion of compensation is reasonable, taking into account all relevant factors including adherence to statutory requirements and industry practice. Fixed pay would include the perquisites, reimbursable perquisites with monetary ceilings, and superannuation/retiral benefits.
Variable pay can be in form of a mix of stocks as well as cash with a proper balance between the cash and share linked components. In cases where the compensation by way of share-linked instruments is not permitted by law/regulations, the entire variable pay can be in cash.
- Variable pay should be a substantial part of the compensation (at least 50 %), and should be based on individual, business unit and overall business level measures of performance. The variable pay will be limited to max 300% of fixed pay.
- 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.
- If an executive is barred by statute or regulation from grant of share-linked instruments, his/her variable pay will be capped at 150% of the fixed pay but shall not be less than 50% of the fixed pay.
- Provision to the effect that the deterioration in the financial performance of the bank could lead to a contraction in the total amount of variable compensation, including a possibility of zero payout.
- For senior executives, Whole Time Director’s (WTD), and Material Risk Takers (MRT) there needs to be a provision of deferred payout of 60 % of variable pay amount. If cash bonus (> Rs. 25 Lakhs) is a part of variable pay – at least 50 % of cash bonus must be in form of deferred payouts. These payments could be deferred over a minimum of 3 years.
Provision for Clawback
The variable compensation would be subject to clawback arrangements in the event of subdued or negative financial performance of the bank and/or the relevant line of business in any year. Banks are expected to frame their processes and guidelines in the matter by considering Supplementary Guidance issued by FSB in March 2018 on use of compensation tools to address misconduct risk. “The banks shall 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.”
Since, guaranteed bonus is not consistent with risk management – RBI guidelines allow for guaranteed bonus only in case of fresh hiring in form of a joining or a sign on bonus and limited to the first year. Also, the joining bonus must be in form of share linked instruments. These payouts or grants may not be considered as a part of fixed or variable pay.
Employees in Risk Control & Internal Audit
RBI guidelines also presents guidelines for bank employees engaged in financial and risk control, including internal audit. They should have adequate compensation, and compensation practices that allow for their independence so that their authority is not undermined. For these staff members – min 50 % variable pay will not be applicable, however there has to be a provision for clawback of variable pay to keep in account possibilities of misconduct or unethical conduct. As per the guidelines – “These employees should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management’s influence on incentive compensation.”