INTRODUCTION

The Reserve Bank of India (RBI) published the Guidelines on Compensation of Whole Time Directors/Chief Executive Officers/Risk takers and Control function staff (Guidelines) on 13 January 2012. These apply to private and foreign banks. The central government determines compensation packages in state-owned banks.

The Guidelines have adopted the Financial Stability Board Principles for Sound Compensation. These intend to reduce incentives for excessive risk-taking that may arise from compensation schemes. The principles call for effective governance of compensation, alignment of compensation with prudent risk-taking, effective supervisory oversight and stakeholder engagement. They have been endorsed by the G-20 countries and the Basel Committee on Banking Supervision.

The Guidelines provide that banks should plan and adopt a comprehensive compensation policy covering all their employees. This policy must cover aspects such as fixed pay, benefits, bonuses, guaranteed pay, severance packages, stocks, pension plans, and gratuities. The Guidelines call for the board to set up a remuneration committee, to oversee the framing, review, and implementation of the bank’s compensation policy.

For full-time directors and chief executive officers (CEO), it adjusts the Guidelines state that banks should ensure compensation is adjusted for many risks. The Guidelines set out the compensation structure for full-time directors/CEOs with the following components:

1. Fixed pay: reasonable fixed pay, based on factors such as industry practice.
2. Variable pay: a proper balance of variable and fixed pay. The Variable pay should not exceed 70% of the fixed pay in a year. Variable pay can be in cash, stock linked instruments, or both.
3. Clawback: in the event of negative contributions of the bank and/or a relevant business line in any year, deferred compensation should be subject to malus /clawback arrangements.
4. Guaranteed bonus: these contradict a sound risk management or pay-for-performance principles, and should not be part of a compensation plan.

The Guidelines also provide that members of staff engaged in financial and risk control should  compensated independently of the business areas they oversee, and in proportion to their key role in the bank.

The Guidelines provide that foreign banks operating in India must submit a declaration to RBI annually from their head office that their compensation structure in India complies with Financial Stability Board principles and standards.

To ensure regulatory and supervisory oversight, banks’ compensation policies need review. Deficiencies in the policy have the effect of increasing the risk profile of banks, including requiring additional capital if they are very significant.

The Reserve Bank of India (RBI) has issued various guidelines on risk management policies to adopt by banks. Risk management should include:

1. The organizational structure of the bank.
2. A comprehensive risk measurement approach.
3. Risk management policies approved by the board, consistent with broader business strategies, capital strength, management expertise and an overall willingness to assume the risk.
4. Guidelines and other parameters used to govern risk-taking, including the detailed structure of prudential limits.
5. A strong management information system for reporting, monitoring and controlling risks.
6. Well laid out procedures, effective control, and a comprehensive risk reporting framework.
7. A separate risk management framework independent of operational departments, with a clear delineation of responsibility for risk management.