Priority sector lending: Missing the woods for the trees?

Tweaking existing guidelines will help align priority sector lending with current realities

The current banking and economic situation demands a fresh round of thinking regarding priority sector lending (PSL) guidelines. In FY16 the Reserve Bank of India (RBI) initiated two significant steps. First, it revamped PSL norms by including some new sectors such as social infrastructure, renewable energy and medium enterprises among others. Trends indicate that barring renewable energy and to some extent trade, credit to new sectors has not shown any significant expansionary trend. Second was the introduction of the scheme of priority sector lending certificates (PSLC) to facilitate the achievement of PSL targets by banks. This is to incentivise banks having surplus in their priority sector lending to sell this surplus to peers that are falling short. The total volume traded at the end of September 2016 was about Rs 140 billion.
 
What is the status of priority sector credit in the current fiscal? During April-December 2016, RBI data indicates that the incremental credit growth to priority sector expanded at a very slow pace of 0.8 per cent (vis-a-vis 7.3 per cent last year). In FY16, public sector banks (PSB) priority sector loans had registered a strong growth of 13.4 per cent, compared to the overall PSBs’ credit growth of 2.1 per cent (renewable energy and trade contributed, as did the revised norms). On an average, the new sectors have contributed around two per cent to the priority sector lending growth. Despite this, in the last five years, PSBs have been unable to achieve the PSL targets. Their average shortfall in the last five years has been in the range of Rs 545 billion.

Illustration: Binay Sinha

 
It is pertinent to argue here that despite such brouhaha, private sector banks did achieve their PSL targets in the last three years in a row. However, this may not be an appropriate comparison, as PSB PSL loan portfolio is three times higher than their private sector banks’ counterparts. Further, the Nabard balance sheet for FY16 shows a total of Rs 1,89,420 crore in rural infrastructure development fund (RIDF) and other funds being deposited by banks because of shortfall in their PSL targets over the years. The amounts deposited in RIDF and other such funds are also counted towards PSL achievement. However, if these amounts are excluded, the banking system will indeed have an overall shortfall in PSL.
 
What does this shortfall indicate? In FY17 even if we assume that overall PSBs credit expands at a modest rate of five per cent, given the FY16 shortfall, PSL loans will need to grow in double digits, if PSBs have to meet the target, which is challenging given the weak credit demand. Going by this logic, we clearly need to look at the PSL definition once again.
 
There is an additional angle here. When banks fail to meet their PSL targets, they have to invest an amount equal to the shortfall in RIDF maintained by Nabard. RIDF came into existence in FY 1996, with the primary purpose of encouraging commercial banks to meet their PSL targets through interest rate policy instrument, that is, lower interest on investment under RIDF as compared to net returns on priority sector advances. Currently, the interest rate levied on RIDF varies from two per cent below bank rate to four per cent below bank rate depending on the extent of shortfall in PSL targets. This directly impinges on the profitability of PSBs. In a scenario of stressed profitability, PSBs can hardly afford this hit, which has a direct bearing on their profitability and retained earnings as also the need for the government to infuse capital.
 
What could be done to align PSL with the country’s current priorities? It could be a combination of tweaking the existing guidelines with some policy changes. A few suggestions:
 

• There should be some clear definitional changes in PSL at least with reference to the quantitative caps. MSME lending is an integral part of the priority sector. However, the definition of MSME, based on original investment in plant and machinery, is dated (2006); broadening the definition in line with the current economic conditions is required. There needs to be a serious relook at the cap of Rs 5 crore per borrower for building social infrastructure activities like schooling, health care, drinking water and sanitation facilities in Tier II and Tier VI centres. The cap of Rs 15 crore for borrowers (individual households: Rs 10 lakh) related to public utilities under renewable energy must be increased manifold to make it a meaningful proposition in accordance with the current vision of the government.
• Another area worth considering is expanding the definition of rural infrastructure to include rural roads, feeders, power plants, bridges etc. This is exactly in consonance with what RIDF does with the surplus funds.
• Food credit is an important component of the banking system and the government has been focusing on food security. We should consider including food credit under PSL as such credit is primarily used for procurement of food grains, ensuring food security, especially for weaker sections of society. 
• The government has stressed the need for adequate credit flow to the infrastructure sector as also towards the affordable housing needs of the country. Alignment of priority sector guidelines with the affordable housing definition will incentivise banks to lend more to the affordable housing segment.
• It might be worthwhile to make an objective assessment of whether we should include municipal bonds under PSL norms, as it will meaningfully facilitate raising of funds for the necessary improvement in social and economic infrastructure of cities. This is also consistent with the smart city project. According to government statistics, a cumulative amount of Rs 1,750 crore ($0.3 billion) has been raised through municipal bonds in India, while South Africa saw $1.8 billion being raised through such bonds in a single quarter alone.

 Clearly, there is a compelling case for more changes in PSL guidelines.
 The author is deputy managing director and chief financial officer, State Bank of India. Views are personal