Priority Sector Lending
Priority sector lending (PSL) is a special mechanism geared towards providing institutional credit to sectors and segments for whom getting credit otherwise is an arduous task. As far as the priority sector norms are concerned, scheduled commercial banks are supposed to give 40 percent of their loans to the identified priority sectors as per the regulations of the RBI. This stipulation of the 40 percent of loans is supposed to be measured in terms of Adjusted Net Bank Credit (ANBC).
Priority sector was first defined in 1972 in a proper way. It was defined after the National Credit Council emphasized that there should be a larger involvement of the commercial banks in the priority sector. The sector was then defined by Dr. K. S. Krishnaswamy Committee. In 1974, the banks were given a target of 33.33 % as share of the priority sector in the total bank credit. However, later on the basis of Dr. K S Krishnaswamy committee, the target was raised to 40%.
The priority sector regulations are supposed to be changed at different time intervals by setting limits for subsectors and other qualifications for the beneficiary groups getting PSL benefits. The RBI has clearly defined that if these PSL targets remain unmet then the defaulter bank will have to finance the development programmes implemented by the government for the concerned sectors. In April 2016, the RBI came up with another innovation in this sector by introducing Priority Sector Lending Certificates (PSLC). This was a pragmatic way to balance the interests of sectors meant to be the target of PSL and the contextual requirements of banks which are unable to meet the PSL target sometimes. Under this innovative PSLC arrangement banks can trade the loan certificates given to the different sectors to meet their targets.
New Priority Sector Lending norms
The RBI has gone for modification of Priority Sector Lending norms after the recommendations of the Internal Working Group in 2015. There have been suitable modifications in the categorization of the priority sectors and relevant targets were set as per the new norms. Following are the main categories of PSL:
- Agriculture (18%): Within the 18 percent target for agriculture, a target of 8 percent has been set for small and marginal farmers.
- Micro, Small and Medium Enterprises: This is again a very important segment of PSL wherein banks are supposed to give 7.5 percent of its loans.
- Export Credit: Incremental export credit of up to 2 percent for domestic banks and foreign banks with 20 branches and above.
- Education: Loans to individuals for educational purposes including vocational courses upto Rs 10 lakh.
- Housing: Loans to individuals up to Rs 28 lakh in metropolitan centres (with population of ten lakh and above) and loans up to Rs 20 lakh in other centres for purchase/construction of a dwelling unit per family.
- Social Infrastructure: Bank loans up to a limit of Rs 5 crore per borrower for building social infrastructure for activities namely schools, health care facilities, drinking water facilities and sanitation facilities in Tier II to Tier VI centres.
- Renewable Energy: Bank loans up to a limit of Rs 15 crore to borrowers (individual households- Rs 10 lakh) including for public utilities like street lighting systems, and remote village electrification.
- There are other categories like self-help groups (SHGs) which are supposed to be the prime focus area of priority sector lending.
The PSL criteria serve a social purpose of inclusive growth trying to create opportunities for the marginalized sections in sync with the Gandhian ethics and values outlined in the Indian Constitution. The robust practical implementation of PSL is needed for the creation of a welfare state in India. Under the overall PSL categories a subcategory called “weaker sections” has also been identified so that they can get special preference under the PSL arrangement. The new regulations specify that banks should give 10% of their loans to the weaker sections. The “weaker section” is a broad category in the PSL framework. Priority sector loans to the following borrowers are considered under weaker sections category:-
(a) Small and marginal farmers;
(b) Artisans, village and cottage industries where individual credit limits do not exceed Rs 50,000;
(c) Beneficiaries of the National Rural Livelihood Mission (NRLM); (d) Scheduled Castes and Scheduled Tribes;
(e) Beneficiaries of Differential Rate of Interest (DRI) scheme;
(f) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY);
(g) Beneficiaries under the Scheme for Rehabilitation of Manual Scavengers (SRMS);
(h) Loans to Self Help Groups;
(i) Loans to distressed farmers indebted to non-institutional lenders;
(j) Account holders under Pradhan Mantri Jan Dhan Yojana (PMJDY)
The RBI wants to focus on agriculture and farmer welfare especially through this PSL among other things. It is the utmost priority of the government as well as the RBI to give special attention towards agriculture and related sectors. Hence, food- and agro-processing units have been included under agriculture and they qualify for PSL benefits.
As far as the calculation of the non-fulfilment of the PSL requirement by banks is concerned, it is being assessed on quarterly average basis at the end of the respective year from 2016-17 onwards, instead of annual basis.
The RBI has been very practical in its approach towards the banks regarding meeting PSL targets. It acknowledges the fact that the banks can at times fail to meet the PSL targets and has made rules accordingly. Scheduled Commercial Banks (SCBs) having shortfall in lending to priority sector/subsectors vis-a-vis the specified targets, are supposed to “contribute to the funds of Rural Infrastructure Development Fund (RIDF) and similar funds set up with National Bank of Agriculture and Rural Development (NABARD) / Small Industries Development Bank of India (SIDBI) / National Housing Bank (NHB)”.
Differential PSL requirement for foreign banks
The RBI has also adopted a very nuanced approach regarding PSL norms for foreign banks. Foreign Banks (with 20 branches and above) have priority sector targets of 40% and sub-targets for key segments like agriculture and weaker Sections. Foreign banks (with less than 20 branches) are supposed to move to the total priority sector target of 40 percent by 2019-20.
Constraints in the Priority Sector Lending (PSL) Framework
- Priority Sector Lending is a desirable activity sanctioned by the RBI for banks. Under the PSL framework banks keep aside a fixed amount of credit for giving them to priority sectors like agriculture, food-processing industries, MSMEs etc. which are specified and revised periodically by the Reserve Bank of India (RBI). The PSL norms seeks to attain financial inclusion and inclusive growth by ensuring that sectoral growth is not hampered by the dearth of adequate and timely credit. However, in practical and operational terms, PSL framework is beset with various structural obstacles:
- Banks are sometimes unable to fill up the mandated PSL credit due to dearth of banking networks in remote areas, elevated rates of default etc.
- There is a serious dearth of financial literacy and farmers are sometimes afraid of accessing formal credit. Thus, out of sheer ignorance farmers in rural areas rely on money-lenders who lend money at very high interest rates.
- There are other procedural complications. The verifiable land records are not present in most of the cases which makes agri-lending difficult. The modernization of land records is still to get top priority. Further, there are marginal farmers and share-croppers who are not the actual possessors of land and hence they are bereft of getting PSL benefits.
- Farmers are very distressed in rural India given the enormity of the agrarian crisis that has gripped the large parts of the country. Such farmers are not allowed to borrow for household distress under the PSL arrangement. Additionally, another priority segment of MSME lending is hampered by the sheer negligence of illiterate small businessmen. It is also restricted by the fact that reliable financial history is not available for smaller companies.
How to resolve these obstacles?
Several committees viz. the Narasimhan committee, Nair committee etc. have opined that there should be reforms in the PSL framework. They say, “PSL should be the exception rather than the norm”. Moreover, there are other related issues to be addressed like the urgent need to spread the formal banking network especially in the remote areas of the country.
There is also a need to relax tied PSL viz. agri-lending only for specific purposes by giving greater discretion to banks by the RBI. Banks should be provided with flexibility in provisioning for PSL.
The PSL norm should not be a strict percentage. Moreover, sectoral targets under PSL may be abolished or at least revised in a realistic way. There are experts who argue that the government-directed PSL lending smacks of socialist bias which is out of sync with the increasingly reform-oriented and market-driven Indian economy. They further say that it is unethical to spend tax payer’s money in such an unproductive manner. However, in India it is also unethical to argue that there should be an outright abolition of the PSL requirements given the vast spread poverty in the country. However, the PSL norms should be rationalized in a realistic way in sync with its true objectives, while not restricting the overall lending operations of the banks.
Priority Sector Lending Certificates (PSLC)
The RBI has brought up another innovation in the form of priority sector lending certificates (PSLC). In this framework, banks can buy and sell PSL credits to manage their priority sector lending requirements especially any shortfall in their PSL target.
Banks operate in a fluid and challenging economic scenario. There are times when banks are unable to meet their stipulated PSL target. So, as per RBI stipulations these banks face the punishment to finance the development programmes of the government. In this context, to encourage lending to the priority sector, the RBI has introduced the concept of Priority Sector Lending Certificates (PSLC). The Priority Sector Lending Certificates are certificates issued by banks that have overreached their priority sector lending targets. PSLCs thus can be issued only up to the extent of their over lending to the stipulated sectors. Buyers of PSLCs are usually those banks who could not meet their priority sector lending targets. The price of PSLCs will be determined on the basis of demand and supply that will be reflected in the auction under the RBI’s e-Kuber trading platform.
As per the RBI guidelines, banks can issue four types of PSLCs including three subsector PSLCs- agriculture, small and marginal farmers, micro enterprises and one PSLC for general. The RBI guidelines say that the PSLCs are meant “to enable banks to achieve the priority sector lending target and sub-targets by purchase of these instruments in the event of shortfall and at the same time incentivize the surplus banks; thereby enhancing lending to the categories under priority sector.” There can be different categories of sellers and buyers of the PSLCs viz. Scheduled Commercial Banks (SCBs), Regional Rural Banks (RRBs), Local Area Banks (LABs), Small Finance Banks, Urban Co-operative Banks etc.
Priority Sector Lending Certificates (PSLCs) are a mechanism to enable banks to achieve the priority sector lending target and sub-targets by purchase of these instruments in the event of shortfall. This also incentivizes surplus banks as it allows them to sell their excess achievement over targets thereby enhancing lending to the categories under priority sector. Under the PSLC mechanism, the seller sells fulfilment of priority sector obligation and the buyer buys the obligation with no transfer of risk or loan assets.
Need for promoting flexibility in PSL norms
- A serious lacunae with priority sector loans is the lack of understanding of the sub-sectoral target groups, especially agriculture, MSMEs and the weaker sections. A foreign bank, desirous of opening a bank branch in some remote area to service agricultural borrowers, neither understands its borrower, nor is clearly aware of the legal provisions to recover stressed assets. Additionally, agriculture in India is dependent on the unpredictable monsoon. Hence, the undiversified risk portfolios in such rural areas increase the credit risks for such banks.
- The same is the case of PSL to the micro, small and medium enterprise (MSME) sector. The sector has largely unorganized operations marked by absence of proper accounting records and financial statements. Hence, it poses greater costs and magnified risks in credit disbursement. In this scenario it is hardly surprising that foreign banks have been reluctant to open new branches in India. The PSL norms are meant to promote financial inclusion by lending to vulnerable segments. However, there is a genuine business case for allowing flexibility in sub-targets for various categories of priority sector lending by giving more freedom to the government.
- The private sector banks have a different business operation mode. They would prefer lending housing credit in urban areas. Logically, they would not like to be forced to lend for agricultural finance. Hence, there is an overall need for giving flexibility to all categories of banks in meeting PSL requirements. Alternatively, the government should use specialized institutions such as the National Bank for Agriculture and Rural Development (NABARD) to fulfil sectoral lending targets.
Are PSL norms causing “Double Financial Repression”?
The fundamental rationale of the priority sector lending programme is to ensure that adequate institutional credit flows into some of the vulnerable sectors of the economy. It has magnified level of importance as the sectors within PSL category are otherwise not attractive for the banks from the point of view of profitability. Some experts also say that the PSL norms are causing “Double Financial Repression”. Priority Sector lending in India receive utmost priority in the banking system in India because of the underlying socio-economic objectives catering to the special needs of the vulnerable sections of the society. However, banks are also required to keep certain amount to maintain Statutory Liquidity Ratio (SLR) and from the remaining disposable amount, 40 per cent is devoted exclusively to the priority sector. Thus, this arrangement causes the so called “Double Repression” on the banking system. The Economic Survey 2014-15 had aptly recommended the government to re-structure SLR and Priority Sector Lending norms as it elaborated the pitfalls and contradictions associated with the “double financial repression”.
Public sector banks have been continuously underperforming on the total priority sector target of 40% since 2012. Private sector banks have continuously lent more than the mandatory target of 40% with certain exceptions. Foreign banks also outperformed their mandated target of 32% throughout the previous decade till 2015-16, as well as the higher targets required later. However, all banks have defaulted on their sub-sectoral targets, especially that of 18% for agriculture, in most years. These facts and figures point out a unique phenomenon. Priority sector loans have contributed far less to the gross non-performing assets (NPAs) of all three categories of banks (discussed above) than non-priority sector loans. Hence, PSL requirements are not responsible for the greater risk load of public sector banks. But even after that most bankers seem reluctant to lend to the priority sectors.
On 19th June 2018, the Reserve Bank of India (RBI) revised the upwards housing loan limits under Priority Sector Lending (PSL). The housing loans of up to Rs 35 lakh for residences costing less than Rs 45 lakh will now be treated as Priority Sector Lending (PSL) to give a boost to the low-cost segment. The housing loan limits were revised to bring union of the PSL guidelines for housing loans with the Affordable Housing Scheme of the Union Government. This is expected to give stimulus to low-cost housing for the economically weaker sections and low income groups as PSL loans are relatively cheaper than market interest rate.
Historically, bank nationalization has led to more credit to agriculture, villages and public sector undertakings. But strict PSL requirement is not serving the desired purpose now-a- days. The Union Budget 2018-19 focussed on revamping the rural economy. But robust financial arrangements are needed to significantly revamp the rural sector. Quite significantly, an impartial evaluation is needed to see if existing tools such as priority sector lending targets esp. related to agriculture sector and weaker sections are meeting their purpose of revitalising the rural economy.
The overall performance of the financial system depends on the functioning of the public sector banks which account for more than two-thirds of banking business in India. Banks in India require prudential regulation. The rationalisation of the PSL norm is an important area of reform in the banking sector.
An important IMF report on the Financial System Stability Assessment (FSSA) for India pointed out that “since all banks need to follow guidelines and meet targets on PSL, it compromises their independent, risk-based credit allocation policies and strategies”. As the banks are already afflicted with the non-performing assets (NPAs), this PSL becomes an additional burden stifling the profitability of the banks constraining its normal business operation driven by the dynamics of market forces solely. The IMF report further says that the PSL norms “pose a challenge to attract credit to productive sectors and enterprises that the economy desperately needs”. Thus, in a way strict PSL requirements have become a force of drag for the larger economic growth of India.
The banks need to optimise their choices within the larger systemic constraints imposed by the PSL lending targets. They can certainly perform better if there is a more enabling policy environment. The guidelines for agricultural credit and lending to weaker sections are extremely complex. The commercial banks may not be the best equipped to handle beneficiary identification, credit risk assessment and loan disbursement to these sectors. Hence, the IMF report suggests that the “sectoral lending targets should be in the exclusive domain of specialised institutions such as NABARD, regional rural banks, small finance banks and other development finance institutions, and not general commercial banks as is currently the case”. Hence, we need to go for a realistic assessment of the pros and cons of the structural reforms required in the PSL framework by keeping in mind the larger interests of all the stakeholders and the noble needs of social justice and financial inclusion.