One of the many challenges that confront the banking system, something that was discussed in great detail at the Gyan Sangam, the two-day bankers’ retreat in Pune early last month, is the current priority-sector lending (PSL) dispensation. In hindsight, PSL may seem to be a less glamorous challenge given that HR, asset quality, technology, etc, corner most of the attention. However, given that the share of PSL as a percentage of adjusted net bank credit (ANBC) has come down significantly over the years, I am tempted to flag this as a major issue confronting the banking sector. This share was at its peak in 1986-87 at 41.3%; thereafter, it declined to 28.9% in 1995-96 and since 2004-05, it has been in the range of 32-37% (regulatory norm at 40%). We believe that with the changing priorities of the new government, PSL must be rechristened to fulfil the very objective for which it was formalised.
PSL, in its current form, has been mandated by RBI since 1974. Since its inception, the scope of PSL has been modified a number of times and there have been several additions to the sectors covered under directed bank credit. These additions have been frequently modified and even repealed in the subsequent years. Interestingly, there have been several committee reports since then suggesting that the recommendations be revisited. The most recent one is the Nair Committee (2012), which examined the existing classification of PSL and suggested revised guidelines.
Our research shows that in the last 30 years, for every R100 net lendable resources (NLR), R19 has been released due to decline in CRR/SLR reserve requirements, of which R8.0 was for PSL and R11.0 for non-PSL requirements. This clearly shows that the commercial banks may have been constrained by priority-sector lending requirements.
Against this background, we propose the following changes to the current PSL dispensation. First, PSL should be directly linked to credit absorption capacity of the banks for better operational flexibility. In our view, a suitable proxy is the NLR of banks, defined as aggregate deposits net of CRR & SLR requirements. Such a proxy, instead of the existing ANBC, will provide for both higher PSL and non-PSL lending, at the existing 40% norm (as shown in the accompanying table). Thus, it will be a win-win situation for both banks and stakeholders.
Second, there is also an immediate need to revisit sectoral targets. In this context, let us take the example of the ‘18% for agriculture sector’ PSL norm (13.5% direct and 4.5% indirect in RIDF). The Indian economy has been transformed substantially in the last few decades. The share of agriculture and allied activities in GDP has moderated from 35.7% in 1980-81 to 14.5% in 2014-15 (Q2), but the share of agriculture lending in the priority-sector is still at 18%, as it was fixed 35 years back. Additionally, average loan per unit in the agriculture sector is low as compared to average loan per unit in the other sectors. So, there is indeed a need to revisit the sectoral target under the PSL such that the sequestered resources are put to the best possible use and serve the purpose for which they were originally intended.
We propose that rather than a distinction between direct and indirect agricultural advances, a more effective instrument of focussed lending would be to fix a ceiling within the overall target. This could be specifically for lending to small and marginal farmers, who constitute the largest proportion of landholdings in India (> 80% of total farmer households). There should not also be any specific limit on credit or category of borrowers, but the actual credit should be directly linked to agricultural activity.
This apart, given the government priorities in building up rural infrastructure, it would be prudent to include rural infrastructure within the overall ambit of agriculture PSL. These would mean lending to activities like solar generation, wind mills, rural roads, agro-tourism, petty contractors engaged in construction of village road, village water tanks, etc, as a part of PSL. Also, bank finance to agriculture under PSL must cover the entire agriculture value-chain (lending to cold storage and godown, etc) for bringing improvement in productivity, storage and distribution. This will have a direct impact on food inflation.
Likewise, there should be a uniform application insofar as bringing export credit under PSL norms. RBI mandates that commercial banks have to deploy at least 12% of their net bank credit (NBC) to export credit (EC). Over the years, the domestic banking sector performance in this area has been gradually declining. EC has been trailing below 4% of NBC in the last 4-5 years. A significant portion of India`s export now come from services sector where there is little opportunity for working capital funding by way of export credit. It is pertinent to mention here that if export credit is included within the overall ambit of PSL, banks will be incentivised.
There are some other issues also. For example, earlier, term loans were disbursed by term-lending institutions (ICICI, IDBI) and they were out of the preview of PSL guidelines. At present, term-lending institutions have disappeared and banks provide both term-loans and cash credit. Interestingly, under the current dispensation, term-lending of banks is still under PSL guidelines. So, is it not the best time now to tweak the PSL norms, with Gyan Sangam still fresh in our memory?
By Soumya Kanti Ghosh
The author is chief economic advisor, State Bank of India. Views are personal