Nepal Rastra Bank (NRB) recently released guidelines to regulate the remuneration of Chief Executive Officers (CEOs) of banks and financial institutions, four months after its initial announcement on the monetary policy. Despite protests by CEOs, NRB issued a circular, putting a cap on CEO salaries and perks. This has raised some eyebrows in the financial industry. Some CEOs argue that this type of regulation can deter talented people from joining the financial sector.
The NRB’s guideline, at least in part, may be a reaction to the recent US financial crisis, which began taking its toll in 2007. In their recent paper “Regulating Bankers’ Pay”, Bebchuk and Spamann argue that one of the reasons for the recent systemic crisis was the risk-taking behaviour of CEOs for their personal gains. Bank executives share gains that flow to common shareholders, but are insulated from losses resulting from their risky strategies. The NRB’s guidelines could partly be a response to such increasing risk-taking behaviours.
Nepal’s financial sector is in a fledgling state, but CEO pay and benefits have been skyrocketing in recent years in a similar fashion observed in developed countries. There has been a widening gap between the salaries and benefits of CEOs and the rest of the staff within the banking system. It has been reported that the salary of a CEO of a commercial bank has been as high as Rs. 2.1 million per month in addition to performance-based pay and other perquisites, while at the same time, the average salary of office assistants at banks is just Rs. 10,000. Market mechanisms do not validate such a rapidly widening gap and it is definitely a matter of concern.
Financial institutions are not like private industries, they are public institutions by nature. The ever-growing perks and salaries of CEOs tend to bring anomalies in the financial sector. Higher remunerations of CEOs require higher profits in the financial institutions, which may lead some CEOs to ‘cook their books’ and take part in ‘controlled fraud’. Returns and risks are positively related in finance. CEOs driven by personal benefits will take more risks and jeopardise the financial system. In today’s neo-liberal era, the existing
practice in the financial sector seems to follow a policy of ‘gain ours, lose yours’. The NRB’s recent guidelines do not take sufficient measures to prevent such practices, however.
There is no disagreement that compensation should fairly reflect the contributions made by a person. However, the profits of a financial institution do not depend solely upon the CEO. The rest of the staff makes important contributions for the growth of the institution as well, which often gets overlooked when it comes to proportional compensation. Although it is justified for a CEO to get compensated based on his/her performance, the existing pay-scale structure in the Nepali financial sector cannot be explained even by the neoclassical wage theory.
Amidst the expansion of financial institutions managed by highly paid CEOs and opening of new branches, a bitter ‘financial paradox’ can be observed in Nepal because of limited access to formal financial services. Another important point to consider here is that the mushrooming finance cooperatives have been siphoning off a large chunk of banking business from formal financial institutions. However, this has been grossly ignored by the highly-paid, talented CEOs.
Despite the hue and cry, current regulations by the NRB have not barred CEOs from receiving their existing lofty salaries and benefits. This new regulation has just set some limits by categorising salary and benefits into three headings: fixed annual remuneration, performance-based pay and other perquisites. Fixed annual remuneration is capped at 5 percent of the average staff expenses over the last three years or 0.025 percent of the total assets in the previous year, whichever is lower. Other provisions include bonuses as per the Bonus Act, and any other performance-based incentives should be counted in the fixed annual remuneration.
An important provision, however, is that if performance-based pay stands at more than 40 percent of the fixed annual remuneration, CEOs get that extra amount over the span of three subsequent years. Meanwhile, if the institution incurs losses in any of the upcoming three years, the differed amount goes back to the institution, not to the CEO. This is the only effective provision in the guideline that serves to check and balance the pay of CEOs and the financial health of the institutions.
Exempting existing salaries and fringe benefits from the new guidelines will affect only the upcoming financial institutions and any new appointments. Ironically, a cursory look at last year’s balance sheet of a few financial institutions reveals that the majority of the currently serving CEOs’ salaries and perks may fall well below the ceiling set by the NRB’s guidelines, thus reflecting the ineffectiveness of the provision. It is quite likely that talented CEOs may come up with risky financial innovations, like increasing staff expenses by raising salaries or hiring more employees, which could result in the ballooning of the institution’s assets by any means. Increasing staff expenses may inadvertently have a positive impact on employment creation and increased staff income, whereas increased assets, if properly checked by the NRB’s existing regulatory provisions, will result in an increase in financial access.
To sum up, the recent guidelines of the NRB on CEO’s pay is a small step towards maintaining financial stability. Nepal needs effective implementation of other regulatory measures such as consolidation of existing financial institutions, implementation of a deposit insurance scheme, effective capital requirements, leverage limits, liquidity ratio, and proper accounting standards for maintaining financial stability to keep up with the country’s expanding financial sector.
Published in the TKP on December 6, 2010. (jointly written with Kalpana Khanal, UMKC)
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