Priority Sector Lending In India
The work titled ‘priority sector lending in India’ primarily focuses on understanding the concept of priority sector lending (hereinafter PSL) or directed lending. It focuses on the informative approach and tries to answer few necessary questions in order to explore the concept of PSL and its presence in Indian governance. The aforesaid necessary questions are what is meant by PSL? Is there a relation between Priority sector measure such as PSL and the constitutional scheme of India? What are the sectors which are considered to be of ‘priority’? How has the concept of ‘priority sector lending’ being enforced in India? What have been the advantages and disadvantages of the PSL in India in terms of its impacts on the economy on the countries? Whether the trend on inclusions in the priority sector lending is deviating the focus from the core needy sectors of the economy? And is there a need to review the concept and scope of priority sector lending?
The concept of ‘Priority sector lending’ focuses on the idea of directing the lending of the banks towards few specified sectors and activities in the economy. One belief which forms the cornerstone behind the philosophy of priority sector lending is that banks are believed to be the movers of economic growth and that by regulating them the whole economy can be given a different a different shape and texture. The term ‘priority sector’ indicates those activities which have national importance and have been assigned priority for development. These primarily include agriculture, small industries etc. The case has further been that these sectors and activities were neglected ones for the purpose of bank credit and therefore for the purposes of accessibility of credit, these neglected ones are considered to be at priority for providing credit. The Reserve Bank of India, which is the supervisory body of the banking sector in India, also referred to as the Apex Bank of the country, has from time to time issues instructions/guidelines/directives to the banks in India with regard to the priority sector lending. The scope and extent of the PSL has undergone a significant change in the post-reform period with several new areas and sectors being brought under its purview while there has been demands to include new areas, such as infrastructure, within the ambit of priority sector, there is an apprehension that it will dilute the definition of priority sector with the focus on the needy sectors of the economy and weaker section of the society getting lost.
2. History And Journey Of Priority Sector Lending In India-
The bend of the governance in India towards ‘socialist principles’ and ‘socialism’ was quite evident in the post-independence era especially after the coming into force of the great document called “The Constitution of India” which inherently provided the aims and guidelines of inclusive growth and development through the ‘directive principles of state policy’ and the scheme of the Constitution.
The most primary sector of economy at that point in time i.e. agriculture was in need of funds but it was not the desired avenue for the commercial banks to extend credit due to multiplicity of factors prevalent at those times. The government initiatives such as green revolution etc. also led to significant increase in the demand for credit by the farmers and the cooperative societies and the State Bank of India could not manage to meet the requirements of credit due to its increased demand. Subsequent to this background, the following incidents took place (which have been mentioned in the chronological order) which paved way for the adoption of the concept of ‘directed lending’ which is called ‘priority sector lending’ in India-
·In July 1966, the All India Rural Credit Review Committee was set up in July 1966 to reassess the situation of rural credit by different credit agencies and to make recommendations for improving the flow of credit to agriculture and it recommended that the commercial banks should play a complementary role, along with the cooperatives, in extending the rural credit.
·The term ‘priority sector’ was first used in terms of policy measures when the then Deputy Prime Minister and Minister of Finance, Sri Morarji Desai stated in Lok Sabha on December 14, 1967 that there are persistent complaints that several ‘priority sectors’ such as agriculture, small scale industries and exports have not been receiving their due share of bank credit.
·Social Control Measure over Banks- The policy of Social Control of the Banks was a major rationale behind bringing forth the priority sector lending for the banks. Social control demanded the banks to align their operations in line with the national objectives which were inclined towards socialist principles. It facilitated the government to have controls over the affairs of bank management in order to supervise that the affairs of bank also keep in consideration the national objectives. The Banking Laws (Amendment) Act was passed in this regard in 1968 which came into force on 1-2-1969.
·National Credit Counciland its Recommendations- This body was set up in 1968 to estimate the demand for bank credit from the different sectors of the economy and the report focused on the need for coordination between cooperative banks and commercial banks in order to achieve optimum utilisation of resources and to replace the exploitative money lenders.
·Nationalisation of Banks- perhaps, it was believed or experientially found that ‘Social Control without nationalisation had no meaning’ and in 1969, the government under the leadership of Smt. Indira Gandhi took a step which is till now considered to be the milestone in the history of banking sector in India. The coming into effect of the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, fourteen major banks were nationalised in order to avoid concentration of economic power and to ensure credit to the neglected sectors of the economy.
·In 1972, the description of the priority sector was formalised on the basis of the report submitted by the Informal Study Group on Statistics relating to advances to the priority sector constituted by the RBI in May 1971.Initially, there was no specific target set for lending to the priority sectors but in November 1974, the banks were advised to raise the share of these sectors in their aggregate advances to the level of 33.3 percent by March 1979.In 1974 only, the private banks were also advised by the RBI to reach a level of not less than one third of their total outstanding by March 1980 at par with the public sector banks.
·In 1980, on the basis of the recommendations of the Working Group on the Modalities of priority sector lending by banks chaired by Dr. K.S. Krishnaswamy, all commercial banks were advised to achieve the target of PSL at 40 percent of the bank advances by 1985. Not only that but also the sub-targets were also specified for lending to agriculture and the weaker sections within the category of priority sector.
·Since then, there have been several changes in the practice of priority sector lending which include changes in the scope of priority sector lending by inclusion of various other sectors from time to time and also the scope of targets and sub-targets under applicable to the various bank groups have also been modified from time to time as per the instructions of the RBI.
3. The ‘Priority Sector’ Category In India-
When PSL was initially formalised in 1972 with the recommendations of the Informal Study Group on Statistics relating to priority sector, it constituted the following categories-
·Small Scale Industries
·Road and Water transport operators
·Professional and self-employed persons
Then, no targets were imposed on the banks for giving loans to the priority sectors and the sectors under priority list were conferred with two benefits; one with regard to the priority in sanctioning of credit and the other in the form of concessions in terms and conditions including rate of interest.
As per the RBI Circular dated July 7, 2016, eight categories have been identified under the head of priority sector lending which are
1.Agriculture (which includes the sub-categories namely Farm credit, Agriculture Infrastructure and Ancillary activities).
2.Micro, Small and Medium Enterprises
Presently, the total PSL contribution for domestic scheduled commercial banks and the foreign banks with 20 branches and above is 40 percent of the ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher and the foreign banks with less than 20 branches have to achieve this target of 40 percent in a phased manner by 2020. The Sub-targets fixed are 18 percent for Agriculture sector, 7.5 percent for the Micro Enterprises and 10 percent in the category of ‘Advances to Weaker Sections’.
4. Impacts of The Directed Lending/ Psl on The Banking Sector And The Economy-
The advocates of PSL claim that it lifts up the weaker sector which the market forces usually fail to do. It is also claimed that PSL results in social returns and improved lending portfolios of the banks. The directed lending allows the commercial banks to generate high social returns along with the profits and it also contributes to economic development by increasing investment in the strategic sectors, like exports. Most important of all, from the viewpoint of public policy, the directed lending promotes social equity and facilitates increase in employment and investment in less developed regions and the vulnerable sections of the society. The opponents, on the other hand believe that it diverts funds from the productive sectors, imposes economic burdens on the banks in the form of loan losses and payment defaults and also imposes opportunity costs of lending to non-priority sectors of the economy. These negative effects are increased transaction costs, increased NPAs and the decreased deposit mobilization. Since the subsidized nature of loans under the directed credit forces the banks to pay lower interest rates on deposits, this makes the deposits a less attractive avenue for the people which ultimately impacts the banks. In cases like India, where the capital markets are not much developed and multiple demands of credits arises from various sectors, these quantitative targets based on the proportion of gross advances effects lending to equally important sectors such as infrastructure.
·Priority Sector Lending and the problem of NPAs -
Non-performing assets are those assets of the bank which cease to provide any return to the bank. NPAs, now days, have become a big problem for the banks as it has been a major concern for the bank promoters and government. The RBI defines a NPA as a credit facility with interest or principal instalments overdue for 90 days.The NPA ratio has an inverse relation with the asset quality of the bank. The NPA ratio for the public banks is much higher (almost thrice) when compared with the private and the foreign banks. It is actually so given the vast scale of lending which a public bank provides across the nation. In PSL, the banks have little power in allocating the credit, and must lend to sectors marked by a relatively large number of defaults due to factors specific to those sectors. The banks then have to set aside the capital to account for assets that might be decreased due to NPAs which erodes the profitability of the banks.
Apart from NPAs, there are other indirect costs on the banking industry by a sort of penalizing the banks for expanding their scale of lending. Since the computation of the PSL target of the bank is based on the previous year’s Adjusted Net Bank Credit (ANBC), it deters banks from expanding their current year’s scale of lending because it would ultimately increase the bank’s PSL target for the next year.
There are also few direct costs involved due to PSL which are the funding cost, the transaction cost and the credit costs which the banks have to borne. Here, transaction cost is the cost of delivering the credit to the borrower which includes wages, salaries, printing, rent, electricity, connectivity, transportation of cash, insurance, overhead and depreciation etc. For priority sectors, especially agriculture, loans are often small and the number of borrowers are large, which increases the transaction cost for delivering the credit.
5. Review of PSL In India
Can the PSL as a concept and as a practice be ‘reprioritized’? Is there a need to review the concept and segment of priority sector lending?
The norms of PSL find their origin in the ‘social control over banking’ philosophy which could have been justified according to then prevailing situations in the country. The conceptually, PSL was a compromise which the banks had to make with the profitability as per the norms by the RBI in order to carry on the banking business in India and overtime the norms of PSL were made mandatory to both the public sector and the private sector banks and also to the foreign banks (with certain exceptions) which highlighted that irrespective of the business model of the banks and even in ignorance of other factors such as branch availability etc. the targets and sub-targets of the PSL norms were made applicable to the banks (which continues to be done till now).
It has been long enough since all banks are made to do public function in the form of PSL which is affecting their profitability to a great extent and it is time that this ‘public function’ approach be restricted to the public sector banks and the State Bank of India and the private banks be given a free hand to decide on their investment/lending avenues so that a right balance is struck between pursing profitability and fulfilment of the public functions. What needs to be emphasized is that the profitability of the banks be given due importance by the policy makers since PSL is a costly affair for the banks and it becomes a bitter pill to swallow not only for the banks but also for the whole economy. The following steps can prove beneficial in this regard-
·The scheme of PSL (the fixation of the targets and the sub-targets) must be structured according to the type of bank along various other considerations such as branch availability and the willingness of the bank to lend to a particular sector.
Historically, a crucial difference between the public and private sector banks has been with regard to the willingness to lend to the priority sector but the broadening of the definition of priority sector has lifted the share of credit from both the public and private sector banks which qualify as priority sector. Private sector banks find it difficult to meet agricultural lending sub-target, though they also lend substantially less in rural areas.
Therefore, requiring all banks irrespective of their business model and orientation to lend 18 percent targets to agriculture is not an efficient way to direct credit to agriculture. Meeting this kind of sub-target would be feasible and also fairly easy task for the public sector banks considering the vast number of branches in rural areas and also various benefit from the government schemes. It becomes equally difficult for the foreign banks to fulfil the targets with regard to agriculture since they neither have expertise nor the branch network in rural areas like the public sector banks. However, ‘export credit’ is where they have expertise and this may be designated as the priority sector for them. This would enable efficiency to the foreign banks. The PSL norms may sometimes become a disincentive for the foreign banks and may deter them from opening branches in the country. It must be seen that the foreign banks neither have the expertise nor sufficient means to lend to the agricultural sector and therefore the revised PSL guidelines which subject the foreign banks with more than 20 branches to the same lending requirements as domestic banks do not appear logical and facilitative to the growth of banking sector in India. It would be progressive to specify other sectors as priority sector for the foreign banks.
·Development of Agriculture Sector as an avenue for investment by the private and foreign investors-
It must be acknowledged that agriculture as a priority sector has a special status, a special place other than other activities which also find place in the head of ‘priority sector’ of the country. The reason for this are historical. It is believed that ‘India lives in villages’ and the role of agriculture in the economy (in terms of contribution to GDP and also in terms of the number of persons employed in the sector) cannot be ignored. The dependence of this sector on credit has been perennial and in recent years of independence and before the inception and implementation of the concept of PSL, the demand for credit was largely fulfilled through the informal sources and the implications of the informal credit mechanism on the farmers were drastic considering the possibilities of economic exploitation of the borrowers (mainly farmers).
Of the total amount borrowed by the cultivators in 1951-52, nearly 70 percent was contributed from the moneylenders, only one percent came from the commercial banks and about 3 percent came each from the government and the cooperatives. The situation has increased considerably from the previous situation and now most part of the credit is made available by the formal banking mechanism. To develop the agriculture sector, efforts may be made towards providing effective risk cover to agriculture and to make it more attractive avenue of investment for the private and foreign Investors. Development of rural infrastructure in the form of water, electricity, transport and sanitation infrastructure in rural areas would attract investments into the sector. Encouragement of ‘contact farming’ as an alternate risk management instrument would attract private sector participation and also reduce dependence of the farmers on the formal banking credit. Work can also be done towards strengthening the cooperative banks, regional rural banks and microfinance institutions and also encouraging the opening of ‘small’ finance banks.
According to a research work on priority sector lending / directed lending based on study conducted considering experiences of directed lending in Japan, Korea, China, Brazil and Thailand, the observations or lessons which are drawn out reflect that the directed credit programs benefit the priority sectors if closely monitored by the government and that the government-owned financial institutions if cater to the credit needs of the priority sectors are much more effective than the commercial banks in directing the credit. The other lessons drawn out reflect that although often presumed that credit is a major constraint in the growth of priority sector, it is not so since the other institutional and policy factors also play a crucial role in the growth of the sector. Overall a want of caution is suggested in pursuing economic development by employing ‘directed lending’ since these programs might spur development in the beneficiary sectors but the costs they put on the banking sector and economy as a whole can offset the benefits of such development.
The other pertinent question which needs introspection in the Indian scenario is that whether the trend on inclusions in the priority sector lending is deviating the focus from the core needy sectors of the economy?
It must be understood that situation in the country since the time when PSL was introduced and extended to the private banks and the foreign banks was considerably different from the situation now and in the environment of competitiveness, the compromise with the profitability of the banks must be resorted to by the policy makers only when it is of utmost necessity. In light of the recommendations made under chapter 5 here, the banking sector must be ready to reform to itself and the mandated or directed lending mechanism except for the public sector banks must take a back seat now and wherever resorted to, it must be in accordance with the business model of the banks so that the “efficiency” of the banking sector be protected to the maximum possible.
# R K Uppal, “Priority Sector Advances: Trends, Issues and Strategies” 1(5)Journal of Accounting and Taxation(December 2009).
# http://shodhganga.inflibnet.ac.in/bitstream/10603/8689/11/11_chapter 4.pdf (last visited- Nov 15th, 2016)
# The primary functions of NCC were- to assess the volume of credit required for the economy as a whole, to provide guidelines for the equitable distribution of credit to the priority sector and to ensure equitable distribution of credit in the economy.
# ‘Social Control without nationalisation had no meaning and nationalisation without social control is a fraud’.
# https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9046 (last visited- Nov 15th, 2016).
# https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9046 (last visited- Nov 15th, 2016).
# http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=5761#L2 (last visited- Nov 15th, 2016).
# ANBC = Bank Credit in India – Bills Rediscounted with RBI and other approved Financial Institutions plus permitted non Statutory Liquidity Ratio (SLR) investments in Held to Maturity (HTM) category plus investments in other categories, which are eligible to be treated as part of priority sector lending. Available at- http://mkerj.com/priority-sector-lending-in-agriculture-in-india/
# Suman Vishwakarma, “Social Control over Banking”,available at- https://www.academia.edu/4808740/Social_control_over_banking2 (last visited 15th Nov, 2016).
# http://shodhganga.inflibnet.ac.in/bitstream/10603/8689/11/11_chapter 4.pdf (last visited- Nov 15th, 2016)
# Contract Farming is an agreement between the investors (companies, government bodies or individual entrepreneurs) on one hand and the economically weaker farmers on the other hand and the main feature of this contract is that the contractor supplies all the materials inputs and technical advice required for the cultivation to the cultivators.
# Re-Prioritizing Priority Sector Lending in India – Impact of Priority Sector Lending on India’s Commercial Banks, Economic Impact Analysis (December 2013), Available at- http://www.nathaninc.com/sites/default/files/Priority_Sector_Lending_India.pdf (last visited- Nov 15th, 2016)