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EXECUTIVE REMUNERATION PERSPECTIVERBI ISSUES GUIDELINES ON COMPENSATION

ABHASHABHINAVAISHWARYA SHULINForeign banks under RBIs control

IMPACT: Interlinked banking system collapses if the risk due to this gap in regulation is not addressedPolitical FactorsFinancial Crisis of 2008-2012

Eurozone double dip recession

IMPACT: Reduce focus on short-term profits and link compensation with the long term implications of executive decisionsEconomic FactorsIncreased transparency to regulators

IMPACT: create more confidence among investorsSocial FactorsBanking Law (Amendments) Act 2012

In favor of Private Sector Banks

IMPACT: RBI needs to take action to protect the interests of prefernce shareholdersCultural FactorsIntroduction of the guidelines

IMPACT: Compliance is MANDATORY for Private Sector BanksLegal FactorsBased on this, risk is countered by maintaining adequate capital. So, any unnecessary risks taken by executives is countered by maintaining adequate capital for the same. This shows need for more stringent regulation to protect investor interestsBASEL III GuidelinesGUIDELINESReview compensation policyBanks to conduct annual review of compensation policyObjective: Governance of compensation

#1 Comprehensive Compensation PolicyProsConsTransparency & EquityPolicies to undergo Supervisory reviewNo excessive compensationCompensation not on banks discretionHigh returns not proportional to higher risks

Banks to establish a remuneration committee (RC)RC to oversee framing, review and implementationObjective: Governance of compensation#2 Constitution of a Remuneration CommitteeProsConsMajority members independent non-executive directorsClose coordination between RC and Risk Mgmt. CommitteeRM committee unfamiliar with compensation principlesTraining sessions needed for RM members

Remuneration grants need RBI approvalVariable pay 70% of Fixed payMix of total pay 60:40 (FP: VP)Deferrals on VP 50% of FPMalus and claw back clauses includedESOPs not to be included in Variable componentNo sign-on bonus in up front cashObjective: Alignment of compensation with prudent risk taking

#3 Compensation structure & Schedule for WTDs/CEOsProsConsDiscourages short term approach to risk

No additional incentives on risk takenPrecise ratio not prescribed by European BanksMalus & claw back clauses demotivating in natureLesser freedom to PSBs to offer competitive packagesPersonal hedging/insurance arrangements are prohibited

Compensation structure should be weighted in favor of fixed compensationShould not be significantly influenced by business areas overseen by risk control & compliance staffObjective: Alignment of compensation with prudent risk taking

#4 Compensation structure & Schedule for Risk control & Compliance staffProsConsDiscourages short term approach to riskBusiness in risky sectors discouragedApply guidelines pertaining to WTDs/CEOs to all other categories of staff as wellBonus pools typically adjusted on basis of organizational or business unit economic profit, economic capital of return of RWAsObjective: Alignment of compensation with prudent risk taking

#5 Compensation structure & Schedule for other categories of staffProsAimed at meeting RBIs supervisory oversightRemuneration aligned with risk and performanceConsiderable effort needed to be spent on meeting the new disclosure requirementsNot only WHAT, but also WHY and HOW of compensation disclosure neededObjective: Effective supervisory oversight and shareholder engagement in compensation

#6 Annual disclosure of remuneration in annual financial statementsProsConsMethodology and process given due importanceLack of clarity on precise disclosure obligationsDefinition of other risk takers undisclosedHow will banking organizations in India address practical issues while managing the complex regulatory environment?PROBLEMPLAN