The Reserve Bank of India (RBI) has turned its focus to the compensation policies of non-banking financial companies (NBFCs), directing scrutiny towards payouts to key management personnel. This initiative comes in the wake of directives issued to NBFCs categorized under the ‘middle’ and ‘upper’ layers of the scale-based regulatory (SBR) framework.
According to industry insiders speaking to Business Standard, the RBI’s objective is to enforce robust governance measures within NBFCs, necessitating board-approved compensation policies. These policies mandate the establishment of a remuneration committee and provide guidelines on fixed-variable pay structures and claw-back provisions.
The RBI’s annual report for the fiscal year 2023-24 underscores upcoming regulatory goals, emphasizing the delineation of roles for key committees such as audit, nomination and remuneration, and risk management. These roles are critical components of the SBR framework introduced on October 22, 2021, aimed at enhancing systemic stability and curbing arbitrage in the financial sector.
A pivotal aspect of the new guidelines is the stipulation on variable pay, advocating for a higher proportion of variable components at higher organizational levels. The RBI stresses that variable pay should be linked to pre-defined performance metrics to effectively incentivize executives and align their interests with the company’s long-term goals.
Moreover, the RBI mandates that a portion of variable pay be deferred, aligning with the time horizon of associated risks. This requirement applies to both cash and non-cash components of executive compensation, aiming to mitigate short-term risk-taking behavior.
The SBR framework classifies NBFCs into four tiers — base, middle, upper, and top — based on their asset size. As of September 30, 2023, NBFCs in the middle and upper tiers collectively accounted for a significant portion of the sector’s assets, reflecting their systemic importance.
In April 2022, the RBI issued specific guidelines on ‘Compensation of Key Managerial Personnel (KMP) and Senior Management in NBFCs,’ effectively aligning practices in these companies with those of senior management in private banks. This move underscores the RBI’s commitment to harmonizing governance standards across the financial sector.
Furthermore, the RBI’s Internal Working Group (IWG) on ownership guidelines for private banks, launched in November 2020, has recommended allowing large corporate houses, including sizable NBFCs, to promote banks. This recommendation, still under review, could potentially pave the way for the transformation of leading NBFCs into full-fledged banks.
In light of these developments, several prominent NBFCs are reportedly reevaluating their strategies regarding banking licenses. The recent merger of HDFC entities and ongoing regulatory discussions have heightened interest among large NBFCs aiming to leverage new opportunities in India’s evolving economic landscape.
As regulatory scrutiny intensifies and economic ambitions grow, the path ahead for NBFCs promises to be shaped significantly by adherence to stringent governance norms and strategic alignment with the RBI’s evolving directives.
