Indian state-owned banks introduce performance-linked incentive packages for employees: the true story

According to a report in today’s Business Standard, India’s finance ministry decided on a reform plan to improve efficiency in state-owned banking sector. In the plan, not only the chairmen and executive directors but also ordinary employees are entitled to  performance-linked incentive packages.

“Heads of 29 public sector banks are set to get a performance-linked annual incentive package. Besides, all of them will get a lumpsum ex-gratia payment on retirement, depending on the number of years they put in as directors on bank boards.  Down the line, close to 800,000 employees in the public sector banking industry, too, will get incentives, based on their performance in five key areas.”

Five parameters are considered to determine the size of annual bonus,  which includes “credit growth, deposit mobilization, quality of assets, and recovery of non-performing assets.” (The report mentions only four parameters though).

I don’t think such design can help achieve the efficiency goal.

First of all, credit growth and deposit mobilization has nothing to do with efficiency; to the contrary, for India, faster credit growth and deposit mobilization  in state-owned banks actually reduce financial stability and crowd out efficient investment (as state-owned banks typically use the deposits to purchase government bonds instead of to invest in good projects).

Secondly, the “incentive” package is not linked to individuals’ performance but the performance of the whole bank. No employees will work hard to improve quality of assets or to recover non-performing loans, because (1) if he works hard, his colleagues in all branches across India can free-ride on the results as well (2) if he doesn’t work hard, he can still receive bonus pay so long as his colleagues work hard (3) knowing this, no one work hard.

There are restrictions on the total size of the incentive package: “The maximum amount a bank can pay to employees through this route will be capped at 1 per cent of a bank’s profit after tax (PAT).”  Nevertheless, no details are given regarding what fractions of this 1 per cent will be allocated to ordinary employees. Theoretically, all of them may be allocated to the CEO, which did happen in many corrupted countries when they introduced so-called “employee” incentive package. As a matter of fact, I also notice that: “Financial incentives given to chairmen and executive directors will be outside the cap (1 per cent of PAT) applicable to bank employees.”  Ha, I caught you!

I speculate that the plan is drawn up simply for the purpose of legally tunneling money from the state treasury to chairmen and executive directors of state-owned banks.

Comments

[ajit]

Credit growth,deposit mobilization and the recovery of non performing assets are the areas where employees working at the branch;especially in rural areas;can make the difference by improving the service.State Bank of India alone has as many as 6700 rural branches.So any such incentive package is welcome.I do agree,Indian Banks do not finance socially productive infrastructure projects like roads,power plants etc.It can also be argued that banks do not adequately finance working capital requirement of the existing businesses, hence Banking sector as such do not exist in India.However Indian Banks,as a part of their committment to priority sector lending,are considerably exposed to the agricultural credit and there is a room for improving the efficiency

[R-Squared]

The report doesn't elaborate on how the compensation package will be implemented. It is not clear whether incentive pay is linked to performance at the branch level or at the bank level. The package will certainly create incentives for employees if linked to branch or office level performance. But I speculate that the main purpose of the plan is to hand out more cash to senior executives in the headquarter.

[Vishal Mate]

I would like to know the prerequisites that the Indian Banks had for implementing the perofmance based pay and what was the post implementation effect?