Priority Sector Lending refers to those sectors of the economy which may not get timely and adequate credit in the absence of this special dispensation.
The Reserve Bank of India (RBI) has given Priority Sector Lending as an important to other banks for providing a specified portion of the bank lending to few specific sectors like agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low income groups and weaker sections. This is essentially meant for an all round development of the economy as opposed to focusing only on the financial sector.
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 measures 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 of 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 have 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.
PRIORITY SECTOR LENDING IN INDIA- History and Journey
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 the 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 the 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 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 the 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 Council and 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 nationalization 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 the banking sector in India. The coming into effect of the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, fourteen major banks were nationalized 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 formalized 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.
CATEGORIES OF ‘PRIORITY SECTOR’ 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
§ Industrial Estates
§ Road and Water transport operators
§ Retail Traders
§ 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 the 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
3. Export Credit
6. Social Infrastructure
7. Renewable Energy
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 an 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 impact 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, nowadays, has become a big problem for the banks as it has been a major concern for the bank promoters and government. The RBI defines an 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 is the funding cost, the transaction cost and the credit costs which the banks have to bear. 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 is large, which increases the transaction cost for delivering the credit.
According to a research workon 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 catering 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 the 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 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.
School of Law