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Bank CEO compensation: Should there be a cap on pay of top bankers?

Madan Sabnavis

While NPA divergence is a serious issue, could there be other issues which are equally or more severe that have been left out in the paper

RBI’s discussion paper on Compensation for whole-time directors (WTDs) and CEOs of non-PSBs is timely and interesting as it ‘mainstreams’ a debate that has been on the sidelines for quite some time. One view has always held, when it comes to the private sector, the regulator should not interfere in the compensation of the CEO and WTDs as it is the prerogative of the shareholders. However, banking is a unique business where the Bank does not do business with the shareholders’ money but the deposit holders’. This does not hold for investment banks or mutual funds or even NBFCs in the financial sector. Therefore, there is a case for arguing for some kind of regulation. Further, unlike the PSBs that get into the net of all the 3Cs, the private banks often are not under such scrutiny.

Should there be a cap on pay? The answer is probably no, as it is still the owner’s prerogative. However, there have been cases of banks’ boards not performing according to industry standards but having high executive compensation. The problem is that the risk-reward matrix is not defined in a transparent manner. Banks are actually sedentary organisations, which take deposits and lend money. They should not be earning extraordinary profits but they do. As they work for enhancing shareholder value, the goal is always to outperform and, hence, bank stocks are blue chips for all times. Therefore, all CEOs work on enhancing profit—done by keeping deposit rates down and lending rates up and pushing the envelope far. Every employee is evaluated in terms of how much business is brought to the table, which creates a hyper-competitive environment. Therefore, there is always a rush to exceed targets with the asymmetric returns being the incentive provided. At times, things backfire.

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The problem with the private corporate sector is that all decisions are taken by boards when it comes to compensation. There is a view that serious discussions seldom take place, and, hence, the issue is more of corporate governance rather than compensation of bank CEOs per se. Even if one looks beyond banks, the compensation can be phenomenal, where there are no defined limits and failure rarely leads to downward adjustments. While all companies follow the practices under corporate governance, the board is often not assertive enough given the stature of the CEO who could be the owner. Therefore, there is now a case for saying that if bank NPAs increase due to egregious and aggressive lending, then the model has failed and the decision taken by the CEO and WTDs was incorrect. But, as they have already been paid for their work and may have moved on, there is an argument that the rewards should be clawed back. As it is hard to make a retired CEO pay, a deferred payment is the option whereby the CEOs are made to pay for their failures.

The question, then, is how far back can one go or when should the deferred payment be made. Should it be for failures over the past 3 years or 5 or 10? If one looks at the NPA problem today, it was due to aggressive lending in the period 2007-2012 when bank credit grew rapidly and CEOs made their money. Banks also showed high growth in profits and revealed benign NPA numbers with the support of regulatory forbearance in the form of restructured assets. Therefore, often the high NPAs that are there today may not be attributable to the undue risk taken by the incumbent CEO but a predecessor, which makes it hard to pinpoint the one responsible. This makes the deferred payment a tricky issue.

Now, the suggestions made on apportioning the compensation across the fixed and variable components make sense and also add transparency as often the stock options are given separately. The problem then goes down the line, too, where there is considerable variation in the pay packages with the top 5%, which could be the ‘favoured’ or the ‘instruments of delivery’ getting considerably higher pay packages. Logically, similar policies must be there for those higher in the hierarchy, too. The paper talks of certain functions like auditing and risk, but should be spread to other hierarchies too. Here, the paper is silent on how the clawback should take place. Interestingly, the RBI paper talks of penalties on the CEO for divergence in stated NPAs. Here, there are two issues that come up for discussion. Is such divergence always due to deliberate attempts to obfuscate or is it because of interpretation as there are always auditors involved here? Secondly, while NPA divergence is a serious issue, could there be other issues that are equally or more severe that have been left out? Therefore, the case should be left open where other so-called ‘incorrect behaviour’ is treated with a similar penalty.

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The issue of compensation to bankers in the private sector has come under the radar due to the controversy regarding performances of some banks in this sector on different counts. The genesis of the compensation issue can be traced back to the time when such licences were issued that brought in higher pay scales for all employees. Subsequently, there was the tendency for bankers to be rewarded with higher pay scales on grounds of superior performances, which were lauded by all. The concept of blowing the balance sheet with aggressive lending was hailed as being driven by animal spirits, and there were no objections raised on the compensation as it set new benchmarks for banking. The stock market also lapped it up. During this phase, the inequality within the organisation was exacerbated with the lower end staff being paid disproportionately lower salaries while the higher echelons were rewarded with stock options. This gave an incentive to take more risk to increase shareholder value in the short-run which finally has come undone in recent times in some cases. Repairing one part of the edifice is alright but the broader issue is how one conducts an otherwise plain vanilla business like banking.

On the other side, having such a payoff matrix would also mean that these jobs may become less attractive, just like in the case of PSBs where there are not too many takers from the private sector. While clawing back makes good moralistic sense, it can come in the way of bringing about innovation and growth with the threat of failure now being the sword of Damocles. PSBs already have a fear of the 3Cs getting after the CMDs at some stage in their retired life. Private bankers, too, would probably prefer the more commercial ventures like investment banking rather than commercial banking where the clawback also goes with a reputation risk. Today, allegations have scarred reputations in an era of media activism where the final conclusion is still not known. Having the ignominy of returning rewards is a real disincentive. Striking a balance will hence be important here as banking reforms always talk of competent management.

(Author is chief economist, CARE Ratings. Views are personal)

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Bank CEO compensation: Should there be a cap on pay of top bankers?


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