The 2007-08 crisis scarred the world’s financial systems leading to major upheavals across the political and economic landscape worldwide. With a decade’s hindsight, it is clear that the crisis had multiple causes. The obvious culprit seemed to be the financial services firms themselves who operated with complacency towards risk and the regulators who were also inadequately vigilant. The compensation practices, especially of large financial institutions, were also established to be one of the key reasons for driving the excessive short-term selling focused behaviour. The practice of 'incentivizing' attracted severe criticism, as the 'right behaviour' was certainly not being driven.
Back in India, the impact of the crisis was limited to a few foreign banks and regulatory systems have always been believed to be watertight enough to curtail any major disruption. However, are there any opportunities for rewards professionals to learn from the 2007-08 crisis? Inherent problems with heavy focus on incentives seem to ignore any specific geography or economy or sector. Not very long ago, the mis-selling of Unit Linked Insurance Plans in India had resulted into an estimated loss of ` 1.5 trillion to investors. So perhaps it’s prudent to keep our guard up and ensure that wrong rewards mechanisms don’t get an opportunity to rock the boat.
Hence, Aon Hewitt decided to decode how the incentives and other pay practices have across banks and Non-Banking Financial Companies (NBFCs) shaped up post the global financial crisis? Have the governance and control functions been empowered to right-set the direction of rewards? Or are there any gaps and loopholes that need to be filled in before it’s too late.
Variable Pay Plans Showing the Way Out to Sales Incentives
To start with, we do see a focus on streamlining incentive programs across both foreign and Indian private sector banks. Overall, from an employee coverage standpoint, Indian private sector banks today lay more focus on incentives than their foreign counterparts.
Across both the segments, i.e. Indian and foreign banks, we do observe incentive eligible population moving into variable pay/bonus schemes, tepidly though. This is good news as variable pay schemes are usually influenced by business unit & organization’s performance and take into consideration the full year's performance of an individual. In contrast, incentive based schemes are tracked & rewarded on a monthly or quarterly basis and thus focus relatively more on rewarding short-term success. This self-contraction of incentives by banks thus is a welcome move.
As illustrated in the chart, the population eligible for incentives has condensed significantly towards lower levels of management across banks. In Indian private sector banks, the liabilities side hunter roles are on incentive plans and farming roles are moving towards bonus or variable pay plans gradually and on the asset side some banks do not have an incentive plan at all.
Most Indian private sector banks have capped sales incentives with defined ceilings. Even contest and campaign rewards disbursed over and above sales incentives are ensured to fall within these predetermined limits. In contrast MNC banks have a relatively relaxed ceiling which may go up to two times to four times of the fixed pay. About 10%-25% of the earned incentives are deferred to the end of the year. Indian private sector banks have capped their year-end bonuses at 60%-70% of the fixed pay, with deferral clause applicable for any payouts beyond this. Defined payout ceilings and strict repercussion policies aid in containing reckless risk taking, minimizing mis-selling and fraud, ensuring compliance and creating a uniform customer experience.
Governance and Control Functions
Control functions have gained significant importance post the financial crisis. We see a difference between the rate of growth of pay for control functions, visà- vis all other functions. This is a direct outcome of the increased focus on controlling risks and keeping a tighter leash on the processes. The proportion of headcount of control functions in the overall headcount has also increased.
Incentive plans however, continue to be owned by business leaders. So an exhaustive & clearly articulated governing document with clearly carved out accountabilities of business &control functions, frequent reviews and visibility of human resources function remains an area of opportunity.
How are NBFCs Faring?
With a flurry of banking licenses and aggressive rewards strategies, the NBFCs have seen tremendous activity in the past few years. NBFCs have placed significant focus on sales incentive/variable pay which poses a question, looking at the decade old events, if they are headed in the right direction and will be able to inculcate the right behaviours in their employees.
From a pay mix standpoint, we see the NBFC sector not only competing with the banking sector, but also being more aggressive on incentives/variable part of pay. While the junior individual contributor level receives approximately 10% as incentives in the banking sector, this proportion is almost double in the NBFC sector. From an eligibility standpoint, the NBFC sector awards incentives right up to second level supervisors in few organizations, in contrast to the banking sector that restricts the same mostly up to first level supervisors. Another trend in the chart suggests that proportion of eligible employees earning incentives in NBFCs is 20-30 percentage points higher than in the banking sector. Many theorists across the world have questioned the long-term effectiveness of incentives towards driving the right behaviour, and time and again the fragility of short-term incentives has manifested across sectors. Amongst several examples, the story of Wells Fargo scam unfolded because of an intense drive to earn more through cross-sell incentives.
With this being the next big wheel of the financial services industry, i.e. the NBFCs, racing on a remarkable growth journey with the incentive fuelled engine, it is essential for the regulatory set-up and rewards professionals to monitor and steer this in the right direction and ensure a sustainable growth. Robust governance mechanisms, claw backs and checks on the highest limits are some of the aspects that need to be explored.
Changes in Pay Trends Post the Crisis
- The last decade has seen a slower growth in pay (total pay without LTI) in the banking sector as compared to the other sectors in the financial services industry. The lower pay base of other sectors and faster growth in business partially explains the faster growth in pay, thereby resulting in the convergence of pay levels vis-à-vis the banking sector
- The proportion of banking spend in the overall financial services industry has grown considerably, from less than 1/3rd to more than 2/3rd during this period. Now while this disproportionate rise is driven by non-linear factors such as inclusion of outsourced employees onto the banks’ payrolls for a few businesses or due to an inorganic growth, the increase in spend proportion is significant enough to be considered
- When the growth in pay is compared to the growth in operating expenditure and growth in net income, we see a rise in the ratio of pay spend to net income and pay spend to operating expenditure in the Indian private sector banks. Once again, while many underlying factors influence movements in this ratio, the disproportionate rise in pay spend cannot be missed
Has the Realm of Rewards Reshaped in the Last Decade?
Monetary rewards will never lose importance; the key however, lies in the manner and to the extent to which it is linked to employee motivation. It is essential to pay the right amount for right behaviours proactively before problems compound to create macro-economic disruptions. In a developing and young country like India, pay and incentives will continue to be a key driver for motivation. Thanks to the regulators and proactive steps taken by the biggest players in banking, there certainly seem attempts to streamline pay programs & there is a heightened focus on control functions. However, there are many areas of opportunities such as total pay spend ratio monitoring, strengthening governance mechanisms and sharpening claw back clauses. Long-term incentive plans are very effective tools and it needs to be ensured that they are aligned to the shareholder/taxpayer interests. Other financial services sectors, in particular, NBFCs may need to proactively review and define a more holistic incentive strategy, possibly learning from banks.
Order within the realm of rewards is always restored either pre facto or post facto — it did post 2008 for the biggest financial players across the world. The spectrum has two ends and the choice lies with us: shaping behaviours through rewards or behaviours mandating the rewards to re-shape.
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