Bankers' pay cheques now under RBI scrutiny

If you are a private or foreign banker, Big Brother will keep a watch on your salary structure.

The Reserve Bank of India (RBI) on Friday came out with a set of stringent guidelines to govern remuneration paid by private and foreign banks. The purpose: to avoid a "perverse" salary structure - a key reason for the global financial crisis of 2008.

Apart from linking salaries to profitability and the capital base, the RBI has banned any form of severance package except for pension and gratuity, capped variable pay of chief executives and directors and asked banks to have "clawback" clauses.

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These new norms will be effective from April 1, 2012. Though private banks will frame their compensation policy, approval of salaries of CEOs and directors will still need the regulator's approval.

"Employees were too often rewarded for increasing short-term profit without adequate recognition of risks and the long-term consequences their activities posed to the organisations. These perverse incentives amplified the excessive risk-taking that severely threatened the global financial system," the RBI said.

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According to industry sources, the norms may act as a barrier to attract talent in the sector. Representations will be made to the RBI to clarify certain points. For instance, if there is a lay-off, will banks be allowed to pay a severance package? Or, how will banks attract talent, especially from outside the industry?

Under the new norms, banks have to structure salaries in line with their cost-income ratio and ensure the package is consistent with the maintenance of a sound capital adequacy ratio. Private sector lenders must have a compensation policy that will be framed, reviewed and implemented by a remuneration committee set up by the board. The committee will have a minimum of three members, with a majority of independent non-executive directors and at least one member from the risk management committee of the board.

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The regulator said banks had to ensure the salary structure of chief executive officers and whole-time directors (WTDs) was adjusted for all types of risk and consistent with the time horizon of risk. The reasonable fixed pay component should be ensured, it said.

Variable pay for CEOs and WTDs has been capped at 70 per cent of fixed pay and if the variable pay forms a 'substantial' part of the fixed pay, then it has to be deferred over at least three years. Deferred compensation will be subjected to "malus" and "clawback" arrangements in case of negative contributions of the bank or the line of business.

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A "malus" arrangement permits the bank to prevent vesting of all or part of the amount of a deferred remuneration while a clawback clause 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.

Banks can define what constitutes 'substantial' while formulating the compensation policy. Proper balance needs to be maintained between cash and stock (other than employee stock option plans), the RBI said.

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For foreign banks, RBI says, the compensation structure must conform to Financial Stability Report standards and they must submit a declaration annually from their head office.