By Kshipra Petkar
Small finance banks will benefit a lot from the Reserve Bank of India’s (RBI) decision to reduce priority sector lending target from 75% to 60%, as this will give them more freedom to lend and improve profitability, market participants said.
Sarvjit Singh Samra, managing director and CEO of Capital Small Finance Bank, said the 75% mandate led to challenges such as difficulty in finding quality PSL borrowers, lower margins due to high risks, low-yield lending and operational constraints like smaller teams and limited tech infrastructure.
“It wasn’t about lack of demand, but a mismatch between what was expected and what was practical. The new norms aim to solve this — shifting the focus from volume to value,” Samra said.
Ajay Kanwal, MD and CEO, Jana Small Finance Bank, said: “This development should encourage all small finance banks to diversify more significantly. It also sends a positive signal to NBFCs considering SFB (small finance bank) applications — indicating regulatory support for those who demonstrate balanced growth and diversified asset base.”
According to RBI guidelines released on Friday, the priority sector lending (PSL) target for SFBs has been reduced from 75% to 60% while the additional component (35%) of PSL has been brought down to 20%. SFBs will continue to allocate 40% of their adjusted net bank credit (ANBC) or credit equivalent of off-balance sheet exposure (CEOBE), whichever is higher, to different sub-sectors under PSL.
Another impact, according to AM Karthik, senior vice president and co-group head, financial sector ratings at Icra, will be that small finance banks could raise the loan ticket size. “Entities, however, would have to gradually scale up capabilities and processes in new segments, commensurate to the risks involved, especially in the small-ticket unsecured loans (non-microfinance) or loans to businesses/corporates, where their track record is limited.”
Bankers said most small finance banks did meet their PSL targets, but often at a cost. According to the latest RBI annual report, all scheduled commercial banks lent Rs 65.7 lakh crore in 2024-25, which is 43.1% of the ANBC or CEOBE as on March 31. Banks’ priority sector lending stood at 44.4% as on March 31, 2024. All banks had achieved the prescribed 40% overall PSL target during FY25.
In March, the RBI had reviewed and revised master directions on PSL which became effective from April 1. The revised directions included enhancement of several loan limits under PSL categories, broadening of the purposes based on which loans may be classified under ‘renewable energy’, revision of overall PSL target for urban co-operative banks from 75% to 60% and fixation of target for non-corporate farmers, among others.
Kanwal said this move will aid SFBs’ transition to universal banks. “A universal bank benefits from a diversified asset base, and the current environment nudges us toward that goal… it opens up space for us to build a more balanced and diversified asset mix.”
“As we can interpret, the recent decision to lowering the overall PSL target is primarily aimed at fostering SFBs’ strategic evolution, helping them grow. The move is expected to facilitate greater portfolio diversification, nudging SFBs further to expand into other areas, including a larger share of more stable and secured lending…” Baskar Babu Ramachandran, MD & CEO, Suryoday Small Finance Bank, said.
On Monday, shares of small finance banks had a mixed reaction following Friday’s announcement. However, it was mostly because the market was under pressure due to the escalation in Iran-Israel hostilities. Shares of AU Small Finance Bank closed 0.2% higher at Rs 796.25, Jana SFB closed up 3.88% at Rs 506.10, Capital SFB fell 0.96% to Rs 290.00 and Suryoday Small Finance Bank closed 0.64% higher at Rs 140.60 on the BSE.