[This article, authored by Prem Khanal, was published in Republica daily, 2010-12-12. Here is my take on the same issue published in Republica daily two months ago.]
Barely a week after the announcement of the much-delayed budget for the current fiscal year, Nepal Rastra Bank came up with a harsh policy that for the first time checks perks and remunerations of CEOs of banks and financial institutions. Perks and salary of CEOs have been a matter of debate for some time worldwide, particularly after the 2008 global financial crisis. There are numerous examples in the Western countries where greedy chief executives were recklessly found engaged in incentive-guided risk-taking lending, which put their entire institutions at high risk of collapse and ultimately compelled the government to use huge amount of taxpayers’ money to save those troubled institutions. In Nepal, such a scenario can’t be ruled out. Undoubtedly, there is a sea difference between closure of a local grocery store and a bank and the government can’t be a silent spectator when a bank meltdowns and general people lose their lifetime’s savings.
Agreed, as the existing pay scales of chief executives, in some cases, are difficult to justify, a mechanism forged in consultation and participation of stakeholders was in fact an urgent need. More than their salaries, which the banks have to publish in their annual reports, the problem lies in perks that come in terms of vehicles, housing and entertainment costs for chief executives. Since most of such perks are opaquely hidden in account sheets beyond understanding of general shareholders, it is perceived that they are grossly misused for personal benefits.
Having said that, my impression of the directive is that it is too rapid and does more harm by contributing to weakening competition and discouraging innovation in addition to barring best performing employees to enjoy prosperity. Sorry to say, but going by the directive, particularly the first two pages containing the concept of the directive, one gets a sense that Nepal’s chief executives of private banks are being punished for being innovative and for being able to generate healthy returns to investors and corporate tax to the state. Already shaken by a slump in realty sector, fears deepen for the banking sector that the directive can halt the development of one of the most successful and transparent businesses of Nepal.
Till date, Nepal doesn’t have a single incident where the financial health of a financial institution had been problematic just because of high perks and salary of chief executives. In fact, we do have a glaring example of how the fully state-owned and largest Rastriya Banijya Bank and partially state-owned Nepal Bank Limited slipped into a deep financial problem when we relied on cheap and uncompetitive chief executives to lead those institutions for decades. The result: Both institutions were declared technically insolvent and the country had to take a hefty loan of over Rs 5 billion to renovate their financial health but even after a decade of reforms they are still fragile enough to spark a financial meltdown.
Having belatedly woken up to waning credibility of the central bank, the measure seems to have been taken to secure quick popularity and restore the tarnished reputation of the central bank. But bear in mind that the latest effort made by the central bank is not at all a foolproof remedy to deal with what it calls ‘a looming problem in Nepal’s financial sector.’
The NRB seems to be rejoicing on its successes that it has patched up one hole in the financial sector but it seems unaware of the fact that the new measure has opened new big holes for the ‘innovative’ chief executives to continue securing hefty pay in the future. The NRB directive mandated that the perks and salary of chief executive of banks and financial institutions should either be less than 5 percent of the three-year average of employees’ expenditure of the concerned institution or less than 0.025 percent of the total assets recorded a year earlier, whichever low.
One of the ways to raise their earnings will be to raise the volume of staff expenses. For that, they will either try to persuade board of directors to raise the volume of employee expenditures or show soft corner when staffs demand higher pay. Even sometimes the board might find itself helpless in resisting proposals to raise staff expenses in order to retain competent chief executives by raising their pay. Another way will be to increase the volume of total assets so that the chief executive can secure more pay in the coming year. For that matter, chief executives will be encouraged to extend more loans and investments, the two components that command a lion’s share in the assets of a financial institution so that they can claim more remuneration next year. The ultimate consequences of such risk-taking attitude, if it starts showing in Nepal’s financial system, will be far devastating than risk posed by the existing pays to them.
The NRB seems to have tactfully averted a possible confrontation with the powerful and influential CEOs by allowing the incumbent chief executives to continue enjoy their existing earnings even after renewal of their contract of hiring in the same institution. So, established banks and financial institutions will not have to face any serious impact of the new directives as they will continue to have the incumbent chief executives as long as they want. But upcoming financial institutions will face a major problem in finding competent executives. As the staff expenses and total assets of upcoming banks will be in small volume, no experienced chief executive will think of joining a new institution. That sort of situation will discourage new financial institutions coming into operation, thereby limiting competition.
Despite all the above agreements, my objection to the directive is only that the measures are too rapid and too harsh and provides “one-fits-all” prescription to all banks and financial institutions, irrespective of their financial health and past performances. Instead, I think all the banks and financial institutions should have been first divided into two categories – financial institutions having negative and positive capital adequacy ratios (CAR) – and different set of directives put in place for them. The recent NRB’s directive and parameters devised to cap the executives´ pay is perfect to those institutions having negative CAR. However, among the financial institutions having positive CAR, the capping should be slightly relaxed to those institutions that make normal profits, say having return on assets (ROA) up to 2 percent.
However, there should be no restrictions on perks and salaries for chief executives of those institutions that are making healthy returns, say ROA of more than 2 percent on average for the last three years. What ultimately matters at the end of the day is not the chief executives´ salary and benefits per se but how they are performing and how healthy is the financial condition of their institution. If a financial institution makes an impressive return by sincerely obeying all the directives of central bank and prudently meeting all standard parameters, and its CEO ensures good returns to shareholders, the chief executives of such institutions should be allowed to enjoy higher rewards. This is how a state is supposed to promote innovations and entrepreneurship.
(Published in Republica, December 12, 2010,p.6)