The Telegraph
Saturday , January 14 , 2012
Since 1st March, 1999
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RBI check on risky deals
Clawback clause in pvt bank pay rules

Mumbai, Jan. 13: The Reserve Bank of India today announced a new compensation policy for chief executives, executive directors and other staff of private sector and foreign banks operating in India, which will come into effect from April 1.

The policy introduces a clawback mechanism that will enable banks to gouge back payments made in the form of variable pay in “certain circumstances”. It doesn’t clearly spell out what these circumstances are.

The whole exercise has stemmed from the global financial crisis that erupted in 2008 and the belief that it was precipitated by compensation practices that encouraged excessive risk taking behaviour among top executives at banks and financial institutions.

It now appears certain that the new clawback proviso will kick in whenever there is clear evidence that the top executive has indulged in excessive risk taking by circumventing the system of checks and balances within the bank or where the executive is involved in dodgy dealings.

The RBI had issued draft guidelines pertaining to the compensation in July 2010. However, its implementation was put off as it awaited a final report from the Basel Committee on Banking Supervision (BCBS).

Announcing the final guidelines today, the central bank said banks must put in place appropriate modalities to incorporate malus or clawback mechanism in variable pay, taking into account relevant statutory and regulatory stipulations. A malus arrangement permits the bank to prevent vesting of all or part of the amount of a deferred remuneration. On the other hand, clawback 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.

According to the guidelines, banks have been told to maintain proper balance between fixed pay and variable pay for directors and CEOs and that the variable pay component should not exceed 70 per cent of the fixed pay in a year.

The RBI added that the variable pay could be in cash, or stock linked instruments or mix of both and that the employees stock option plan (Esop) may be excluded from the components of variable pay.

If there is a deterioration in the financial performance of the bank, it should lead to a contraction in the total amount of variable remuneration.

If the variable pay constitutes a substantial (to be defined by the bank) portion of the fixed pay, of 50 per cent or more, an appropriate portion of the variable pay (RBI said it could be between 40 per ent and 60 per cent) must be deferred over a period.

“Esop is kept outside the computation of the total compensation of an employee for the purpose of this guideline, but since it is used as a compensation as well as retention tool by banks, the extent of Esop should be reasonable,” the RBI said.

While in the draft guidelines, the RBI had mooted that in the case of whole time directors and CEOs, the annual increase in fixed pay should not generally be more than in the range of 10-15 per cent, its final guidelines do not mention this. It only pointed out that banks were required to ensure that the fixed portion of compensation was “reasonable”.

The RBI is also not comfortable with guaranteed bonuses, which it says should not be part of a compensation plan. “Joining/sign on bonus should only occur in the context of hiring new staff and be limited to first year. However, guaranteed bonus should be in the form of Esops only since payments in cash upfront would create perverse incentives. Further, banks should not grant severance pay other than accrued benefits (gratuity, pension) except in cases where it is mandatory by any statute,” it added.