The Australian Prudential Regulation Authority (APRA) has warned financial services companies that the incentives they pay their executives have to be aligned with the quality within the products they sell.
APRA general manager David Lewis last week drove home the point to a Financial Institutions Remuneration Group annual conference while at the same time saying that the regulator did not have a problem with how much bank executives were being paid, but "why" they were receiving those amounts.
"In the financial sector, as in many other industries, performance-linked remuneration is the norm. And that's fine," he said.
"APRA has no problem with performance-linked remuneration. (Indeed, while APRA may be a public sector agency, we too employ performance-based pay structures.) Sometimes these arrangements can be quite complex and incorporate a range of quantitative and qualitative performance measures. But at their heart, these sorts of incentive arrangements boil down to a simple proposition: 'Sell a widget; get a dollar'.
"Now that's a pretty straightforward proposition if the 'widget' you're selling is a car or a refrigerator, where the return is earned at point of sale. But what if the 'widget' you are selling is a financial product where the pay-off is not so immediate? And what if that 'widget' turns out to be defective? Have you really sold a 'widget' at all?" Lewis said.
He said financial institutions were clearly at risk if their performance incentives rewarded underwriting without also ensuring that the payment of those incentives was aligned to the quality of the business being written.
"Despite all the public angst about the size of bank executive pay packets, we're ambivalent about that. What APRA looks at is not the 'how much' of executive pay, but the 'why'," Lewis said.
"Our concern is to make sure that the remuneration practices adopted by regulated financial institutions are sound and do not imbed 'risk time bombs' on the balance sheet which could undermine the viability of the firm in the future.
"What we look at are the performance hurdles that underpin these pay structures. Are these performance hurdles consistent with the prudent risk management of the firm? Or do the performance indicators used to reward executives promote short-term profits at the expense of the firm's long term sustainability?" he said.
