The regulator should not meddle with staff performance management

Bangladesh Bank (BB) has added a new dimension to regulation by fixing entry level and support staff salaries as well as resetting rules on linking employee performance with employee promotion and retention in private banks.  

The BB circular sets minimum total salaries of entry level officers on probation and afterwards and salaries of bank employed or outsourced support staff; prohibits denying promotion or terminating staff based on failure to achieve deposit targets or alleged incompetence in the absence of any proven misconduct; and exhorts private banks to keep the executive compensation ratio at a "logical" level. 

A major bone of contention is meddling with staff performance management. The rationale behind a financial regulator intervening on how private banks should manage its staff is hard to fathom no matter how laudable the intentions may be.  

Managing people in banks

Banking is a service industry. How banks manage the people is a key determinant of success in the banking business. Efficient risk management is not possible without efficient and skilled manpower. Skilled manpower is in short supply both in quality and quantity. Any resource that is in short supply needs to be properly managed. For this you need to discriminate between the people who deliver and those who do not. This is the foundation of human resource management. 

The BB circular is antithetical to discriminating and differentiating between performers and non-performers. In fact, the circular has made it impossible to distinguish the performers from the non-performers based on the deposit mobilisation metric. It also restricts banks from using performance failure as an "excuse" to deny promotion or terminate staff.     

The clarification issued subsequently (January 25 2022), which says banks can take measures against staff based on specific and proven allegations in accordance with their own corporate policy, is not very helpful. It still leaves unclear the difference between misconduct, which can be proven in principle based on accepted industry wide criteria, and the failure to perform which can only be proven against a performance benchmark that can vary from bank to bank.  

A transparent and objective mechanism for performance management is the key to talent management and succession planning. Failure to achieve the performance target is not misconduct but that does not make it an illegitimate basis for withholding promotion or contract termination in compliance with the labour law. 

Compliance with contract is what matters

The employment contract specifies the rights and obligations of parties to the employment relationship. The employer is obliged to secure work for the employee as agreed upon in the employment contract and provide the employee all necessary means and materials for work, training, a safe and healthy work environment, and remuneration not lower than the statutory minimum wage. The worker's duty is to carry out the job agreed to in the employment contract. 

If it turns out that the employee does not have the necessary professional skills and abilities, suitable social skills, and mindset to perform the work agreed upon, the employer has the right to resort to appropriate measures, including termination or denial of promotion. There is no allegation of misconduct on the part of the employee in this case but there is a mismatch between what the employer expected and what the employee could deliver. It is not clear from the BB circular whether this will be acceptable as a basis for termination or denying promotion. 

Incentivising performance

The bank must find ways to induce its employees to act in the interest of the bank. Employees have their own goals and their own means to achieve them. They can choose to take the bank job or pursue another potentially lucrative job. If they take the bank job, they can choose to actively search for deposit mobilisation and investment opportunities or take it easy doing the minimum. 

Whether the employee invests in a risky or a safe opportunity is public information, but whether the employee searches for such opportunities at all is private. While the bank can observe the outcome of a risky opportunity, the employee alone knows the likelihood of any given outcome for an opportunity prior to investing in it. 

This is where incentive compatibility comes in. The bank must create a compensation system that will provide incentives for employees to act in the bank's interests: working actively, investing in good risk projects that should be funded by the bank, and turning down bad risk projects. From the bank's perspective, arriving at the best employment contract is a question of balancing the costs and benefits of paying an employee a higher or lower wage for this outcome or that outcome, considering how these characteristics of an employment contract affect the bank's profits and the employee's incentives.

To encourage workers to pursue good opportunities and avoid bad ones, contracts must especially reward employees for outcomes that are more likely under good projects than bad projects. Such efficient contracts may depend on complicated risk characteristics of both the type of projects banks want their employees to invest in and the type that banks want them to avoid. By having their compensation at stake, employee incentives are aligned with the bank's.

Who other than the banks themselves can know better what compensation design will work for the type of projects they have chosen to focus based on their values and comparative advantage? The regulator's job is to ensure compliance with the macro and micro prudential regulations, not micro-management of the regulated institutions.

Fairness in executive pay 

The BB circular exhorts private banks to keep the ratio between top and base level executive salaries at a "logical" level. There is no universally acceptable logic defining the compensation ratio even though it is recognised that the banking industry is marked by high-profile executives who receive millions in compensation while at the bottom hundreds of thousands of bank workers make lot less.

A theme of fairness driving executive compensation trends is noticeable globally. But there is no right answer regarding how to measure fairness in executive compensation. While there is no agreement on the definition of "fairness", there is a widespread belief that arbitrary metrics and ratios may do more harm than good. When comparing ratios across organisations, one must consider organisation size, structure, governance, business complexity, total compensation design and a host of other factors. 

Does BB have the capacity to assess these complexities? By putting this into the circular, BB has left open arbitrary exercise of discretion on the part of its officials that does not bode well for the future of the industry.

A clear case of over-regulation

There's a fine line between over and under regulation, where overregulation hampers innovation and under regulation can lead to widespread mismanagement. BB has imposed ceiling on lending rate, set a floor on term deposit rate based on inflation, put in place a myriad of restrictions on non-interest charges and fees and now we have minimum wages at the entry level and an ill-defined rule on promotion and termination. 

There is not much else left of any significance in the banks playbook where the banks can endeavour to innovate. The best they can do under these circumstances is to keep afloat with their hands and toes tied in a web of regulations. Considering the importance that banks have in the nation building process, these could have a bearing on the lives of many who are yet to be touched by the formal financial system.