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The Reserve Bank of India on Friday said private sector banks should subject the variable pay of the whole-time directors and other key personnel to mechanisms that prevent vesting of all or part of deferred remuneration and return of previously paid remuneration.
The abovementioned mechanism will address the issue of negative contributions of the top-rung employees.
To rein in the practice of rewarding employees for increasing the short-term profit without adequate recognition of the risks and long-term consequences that their activities pose to banks, the RBI has unveiled final guidelines on compensation for private sector and foreign banks. The guidelines have to be implemented from financial year 2012-13.
In the case of private sector banks, guaranteed bonus should only be in the form of employee stock option plans (ESOPs) and banks should not grant severance pay other than accrued benefits (gratuity, pension, and so on) except in cases where it is mandatory by any statute.
Calling for a proper fixed-variable pay mix, the RBI said variable pay should not exceed 70 per cent of the fixed pay in a year. The ESOP should be excluded from the components of the variable pay.
Deterioration in the financial performance of the bank should generally lead to a contraction in the total amount of variable remuneration.
Where the variable pay constitutes a substantial portion of the fixed pay, say, 50 per cent or more, an appropriate portion of the variable pay, say, 40-60 per cent must be deferred for over a period.
In case of deferral arrangements of variable pay, the deferral period should not be less than three years.
There should be proper balance between the cash and stock/share components (other than ESOP) in the variable pay in case the variable compensation contains stock or share linked instruments (other than ESOPs).
Hedging
Banks should not provide any facility or funds or permit employees to insure or hedge their compensation structure to offset the risk alignment effects embedded in their compensation arrangement, the RBI said in its guidelines.
Foreign Banks
Foreign banks operating in India will be required to submit a declaration to the RBI annually from their head offices to the effect that their compensation structure in India, including that of the CEO, is in conformity with the Financial Stability Board (FSB) principles and standards. The RBI would take this into account while according approval of CEOs' compensation.
The compensation proposals for CEOs and other staff of foreign banks operating in India which have not adopted the FSB principles in their home country are required to implement the compensation guidelines as prescribed for private sector banks in India, to the extent applicable to them.
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