Accelerating economic growth through prioritising priority sector

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The priority sector lending is mainly intended to ensure that the assistance from the banking system to those sectors of the economy which has not received adequate support of institutional finance. The attainment of the socio economic priorities of the government like growth of agriculture, promotion of small entrepreneurs and development of backward area etc, is the major responsibility of commercial banks. Since seventies, Reserve Bank of India and Government of India has stipulated guidelines for priority sector lending by banks. The same was revised on April 30, 2007 and overall priority sector lending target was fixed at 40 per cent for domestic banks and 32 per cent for foreign banks. However, the banks are not able to reach the prescribed target of lending to priority sector. The small entrepreneurs and farmers are continued to be affected by both credit and demand constraints. Thus, it can be observed that the demand for funds for priority sector viz., small entrepreneurs and agricultural sector is enormous. With this backdrop, the present treatise is an attempt to diagnose the various steps taken by commercial banks on priority sector lending especially in the area under consideration in the context of national scenario.

Present initiative:

The Reserve Bank of India has recently revamped the priority sector lending norms. Now, loans to sector such as social infrastructure, renewable energy and medium enterprises will also be treated as priority sector lending. While retaining the 40% primary sector lending target for domestic banks, the distinction between direct and indirect agriculture has been done away with. This means banks can meet their entire agriculture lending target of 18 per cent of their net loans disbursed in the previous year by funding to indirect agriculture, which includes loans to companies engaged in the agriculture sector.

Direct agriculture refers to individual farmers or groups directly engaged in agriculture and allied activities. Now, food and agro processing units will also form part of agriculture. Loans to build agriculture infrastructure such as cold storage, as well as those for soil conservation and watershed development, will now be considered as farm lending activities. Loans for ancillary activities such as setting up agro-clinics and agribusiness centres will also be part of farm lending. However, for small and marginal farmers, banks have to mandatorily extend eight per cent of their overall loans. Lenders will be allowed to achieve the target in a phased manner like seven per cent by March 2016 and eight per cent by March 2017. A target of 7.5 per cent has been set for micro enterprises.

Moreover, for foreign banks with more than 20 branches in India, the sub-targets for small and marginal farmers and micro enterprises will be made applicable after 2018. Large foreign banks have been asked to meet the priority sector lending targets at par with domestic banks by 2018. The targets for small foreign banks will be brought on a par with those for domestic banks by 2020, in a phased manner. In a notification RBI stated that foreign banks with less than 20 branches will move to the total priority sector target of 40 per cent by 2019-20, and the sub-targets for these banks, if to be made applicable post 2020, would be decided in due course. Providing some relief to smaller foreign banks, export credit up to 32 per cent will be eligible.

Bank loans up to Rs 5 crore a borrower for building social infrastructure for activities such as schools, health care facilities, drinking water facilities and sanitation facilities will be provided in tier-II to tier-VI centres and this order comes with immediate effect. In the renewable energy segment, bank loans of up to Rs 15 crore for solar-based power generators, biomass-based power generators, wind mills, micro-hydel plants, etc, will be considered part of priority sector lending. However, for individual households, the loan limit will be Rs 10 lakh a borrower.

On the home finance front, loans of up to Rs 28 lakh to individuals in metropolitan centres and up to Rs 20 lakh in other centres will qualify under priority sector lending, provided the overall cost of the dwelling unit is Rs 35 lakh in the metropolitan centres and Rs 25 lakh in other centres.

RBI has clarified as housing loans backed by long-term bonds are exempted from the priority sector lending mandate, banks should either include such loans under priority sector or take the benefit of exemption from priority sector lending, but not both. This means if a bank categorizes a home loan under priority sector, it won't get exemption in terms of cash reserve ratio (CRR) and statutory liquidity ratio (SLR). For resources raised through long-term bonds to fund affordable housing or infrastructure projects, RBI had exempted banks for maintaining CRR, SLR. Banks will also be allowed to issue priority sector lending certificates to other lenders to make good shortfalls in meeting targets under this category.

Bank advances to microfinance institutions (MFIs) for lending to individuals, members of self-help groups and joint liability groups will also qualify as priority sector lending provided the MFIs meet the norms prescribed for micro lending pricing and amount. Every quarter, MFIs have to furnish certificates from a chartered accountant, stating these guidelines have been followed.

Trend of priority sector lending:

Today, we have an explosion in banking wherein a bank's most trusted customers are not the rich but the poor. In this context, according to the Annual Report of RBI in 2012-13, 16 out of 26 Public sector banks, 50% of private sector banks (10 out of 20) and 2 out of 41 foreign banks could not meet the targets set by RBI for priority sector lending (PSL). While this figure seems alarming, the question is why the banks have failed to achieve their targets in spite of such huge opportunities in the Indian banking sector, especially in rural areas.  Is PSL a liability and a burden for the banks or an opportunity to explore the virgin market across the remotest territories?

We are aware that the priority sector lending mainly refers to those sectors which do not get sufficient credit on time due to lack of ‘special dispensation’. Those who are directly affected comprises of mainly weaker sections of society like farmers and small scale industries. Some of the reasons for not getting sufficient credit can be:

  • Lack of Credit-worthiness of the firm to repay the debt

  • Lack of collateral security of the individual borrower

  • Lack of sufficient documents needed to be eligible to get a loan

While there is no denying the fact that in absence of sufficient security, the bank has the right not to lend money, thus, the RBI has identified certain sectors as priority sectors for easier credit. In a country where around 50% of population is in agriculture, 29.8% of population below poverty level and only 35.5% Indians avail bank facility, the RBI has identified this as a vital step towards economic development of the country.

A key reason why the commercial banks have become risk averse in lending is the rising level of NPA (Non Performing Asset). Almost half of the total NPAs (47%) of public sector banks are attributed to priority sectors, reducing slightly from 52% in the year 2011. Failures to meet these targets by the banks have to be compensated by contributing towards NABARD's Rural Infrastructure Development Fund (RIDF) or funds of other financial institutions as per the specifications of RBI. This explains why the public sector banks, in spite of having extended reach in the rural areas, are still not able to meet the targets mandated by RBI.

While the commercial banks have struggled to penetrate in the untapped market in the rural areas, the Micro-finance institutions leverage on their ability of reaching out to interior parts of the country and offering credit to the people who otherwise don’t have access to it. Since their cost of capital is high, MFIs charge a higher rate of interest from the beneficiaries. In spite of this they thrive well owing to their model of ‘door-step’ delivery of credit facilities. Rate of default is also surprisingly low. However, in 2010, Andhra Pradesh came down heavily on Microfinance Institutions in India owing to the strong-arm collection tactics followed by them, which drove a lot of farmers to commit suicide.

MFIs follow the Joint Liability model which was pioneered by Mohammed Yunus, founder of Grameen Bank in Bangladesh. Clients form ‘groups’ of five members who share the responsibilities for loan repayment for each individual in the group. These small groups are further organized into ‘centres’ consisting of 4-8 groups each. Weekly centre meetings are held, where borrowers pay back the weekly installments. This kind of group lending system creates peer pressure on members in the group to repay back the loan by causing social embarrassment. The system also encouraged group members to assist defaulting members in cases of genuine difficulties. Within a span of nine years, SKS Microfinance grew to be India’s third largest MFI with 3,80,000 members and a portfolio of Rs. 175 crore. Effective interest rates charged by SKS Microfinance are higher owing to the labour intensive nature of their business model like holding face to face weekly meetings, travelling extensively in spite of the constraint of poor road infrastructure to the interiors in the rural India. The other notable MFIs in India are Spandana, AML and Bandhan etc. Success stories of these Microfinance Institutions in India prove the enormity of market potential which exists in India are huge and untapped in most of the areas. People are ready to pay higher interest rates provided they can avail themselves of the credit facilities in an effective manner.

One major advantage for the commercial banks over the NBFC-MFIs is the lower cost of capital. This enables the commercial banks to charge significantly lower interest rate compared to the microfinance institutions. The commercial banks are larger in size with huge manpower and wider presence across the country. Moreover, most of the commercial banks use technology extensively to improve operational efficiency. However, the lack of technology knowhow among the rural people nullifies much of this competitive advantage. Use of internet banking and mobile banking has little impact in the remote areas. For them, banking is more of a relation which has been utilized by the NBFC-MFIs like SKS. However, in the long run, with the improvement in educational level and electricity in the rural areas, the commercial banks can leverage their technological advantage to good use. Also, ever since reports of increased suicide in Andhra Pradesh, the Government has put stringent laws on the NBFC-MFIs in terms of loan recovery and provisioning. The Government banks are perceived to be more lenient in terms of loan repayment, with little or no history of forceful recovery. It is important to see whether the commercial banks can utilize this advantage to good use.

Strengths of banking sector:

A good strategy for the commercial banks to increase the share under the priority sector is to appoint a team of local people to provide door-to-door services. The employees have to come out of the boundaries of the bank to create a bond with the borrowers. The rules laid down to offer loans to the poor people should be simpler and easier to comprehend unlike the current processes. The borrowers will also feel at ease if local people are recruited for value added service as there won’t be any language barrier. Similarly, for export credit, a possible value addition can increase or decrease of export credit based on rupee fluctuations. According to Federation of Indian Export Organization (FIEO), the share of export credit in total credit has reduced to 11.36% from 19.82% between 2007-08 and 2011-12. While the PSUs might incur short term losses for the same, higher export will lead to more dollar earning and hence reduced Current Account Deficit. Finally a differential interest rate on education loan can be provided to the different section of the society to promote education level. The current literacy rate of India is 82.14% for males and 65.46% for females, which is way below the statistics of developed countries. A differential interest rate will provide lot of encouragement to the weaker section to send their children for education.

Steps to improve priority sector lending:

The Indian banking industry received lot of accolades around the world for being resilient to the 2008-09 global financial crises. But there are opportunities galore to go a step ahead by providing inclusive growth to the society. Improvement in priority sector lending will instill confidence among the weaker section as they will get loans at a cheaper rate. However, care should be taken that such advances are not misused by people other than the needy. The risk of NPA might also increase at certain times, but we believe the long term benefits will eventually win over short term losses. While fiscal measures like Food Security Bill will take care of primary needs, priority sector lending will improve the structural weakness of the country in terms of education and employment. Recent rupee freefall has again pointed to the fact that Indian service led economy is still dependant on the West and any policy changes have detrimental effect on our country. Hence, the people have to be made resilient to such external shocks by improving small scale industries, exports and education level. The issuance of new banking license will make the banking industry more competitive, and the existing banks have to use the early mover advantage by tapping the priority sector. Priority sector lending will remain a liability if banks remain short-sighted and follow their cliché methods of lending. It will become a plethora of opportunities the moment banks reach economies of scale in the remote areas. The success of the NBFC-MFI is an eye-opener to what the banking industry can achieve in the coming days. India is set to become the third largest banking industry in the world by 2025. But looking at the opportunities in the priority sector, we believe the target might be achieved at a date earlier than projected.

Stepping in various measures:

Unused priority sector lending funds of commercial banks will be used to set up the Rs 20,000 crore corpus of the proposed MUDRA Bank. The bank will use at least 65 per cent of its funds for lending to micro enterprises run by members of scheduled castes and tribes. Typically, domestic commercial banks deposit their lending shortfall from priority sector to the Rural Infrastructure Development Fund of the NABARD while foreign banks are mandated to deposit an amount equal to the shortfall in priority sector lending with the Small Enterprises Development Fund of the Small Industries Development Bank of India (SIDBI).

The Rs 20,000 crore corpuses will not come from the Budget but out of the priority sector shortfall. The Reserve Bank of India will give this money, which will be used for re-financing, however, the related Rs 3,000 crore credit guarantee fund for the Bank would be set up through budgetary allocations.

Present Finance minister had in the Union Budget 2015-16 proposed setting up the Micro Units Development Refinance Agency (MUDRA) Bank. In lending, priority will be given to SC/ST enterprises, and the bank, which is expected to start operations this fiscal, would initially be set up as a subsidiary of SIDBI, but the finance ministry would later enact a separate law for it. Ultimately the government will come out with a statute or Act of Parliament to create the MUDRA Bank, but in the meantime, an agency called MUDRA will function as a subsidiary of SIDBI initially. It will start doing its business as early as possible, adding that the statute would define the functions, responsibilities, procedure for refinancing as well as recovery.

The finance ministry plans to rope in non-banking financial companies, small banks and MFIs for lending at the local level while it will also use state cooperative banks and regional NBFCs as an intermediate. Earlier only commercial banks are used as financing source but they are not very familiar on how to lend to micro enterprises. The MUDRA Bank will use anybody in the last mile and intermediate agencies at the regional level. The finance ministry also plans to bring in stringent penal provisions to deal with defaults. Just 75 per cent of the loan amount would be guaranteed through the credit guarantee fund while the remaining 25 per cent would have to be guaranteed by the MFI. The Bank will also levy an initial penalty of 0.5 per cent of the default amount on the lender, and the amount could increase for repeat defaulters.

Strategies to attain priority sector lending:

Some steps are envisaged to change the attitude of the commercial banks towards priority sector lending and to achieve the objectives like;                                                                                   

 - Every bank should train a band of senior- and middle-level employees in the art of lending to the priority sector, both agriculture and small-scale industry and they should continue to be encouraged to upgrade their skills in the latest developments in this area of lending. 
-  Instead of making available priority-sector lending facilities in all branches, every bank should set up specialized branches in all potential centres and extend priority-sector lending through these branches alone where trained manpower should be deployed to facilitate proper sanction and monitoring of these loans and advances.

- The RBI should dispense with the present system of target-oriented lending to the priority sector and banks should be given total freedom to lend to all deserving and productive enterprises according to their own norms of lending without spoon-feeding the banks in this regard. 

-  The present system of allocating 40% of lendable resources to the priority sector by every bank should not be insisted upon and all penal provisions for not achieving this level of lending to the priority sector should be withdrawn with a view to give a free hand to the banks to develop a portfolio of their choice in the interest of improving the asset quality of every bank. 
-  Instead of a penalty-based system which exists at present to penalize the banks who do not reach the stipulated targets, the RBI should come out with an incentive-based system to encourage lending to the priority sector, as an incentivized system will receive better receptivity at all levels, and this will provide the necessary thrust to priority-sector lending by banks. And the incentives could be broadly on the following lines:

a)   The incentives proposed could be on a staggered basis and inbuilt incentives can be provided for reaching a level of 20%, 30% and 40% of their lendable resources and incentives can be considered as under: Branch licensing and the CRR /SLR requirements can be linked to these percentages. 

b)    The staff working in those specialized branches lending to the priority sector can be provided with appropriate incentives based on the level of lending to the priority sector at each of these branches.

c)    A certain percentage of profit can be exempted from income-tax for those banks reaching these levels of lending to the priority sector. 

d)    Any other incentive could be thought of to provide impetus for lending to the priority sector.                                                                
-  All subsidies now provided to banks for lending to certain priority sectors should be withdrawn, and in its place, appropriate fiscal incentives should be provided so as to minimize paperwork and misuse of the subsidy system.

-  In order to encourage the staff of commercial banks to improve lending to the priority sector, the bank managements, particularly in the public sector, should also change their attitude and follow the basic principle followed by banks all over the world that “error of judgment is not negligence”. All loans granted by the branch managers should be viewed from this angle and appropriate protection provided to the operating staff when loans go bad due to reasons beyond their control. This will give the required comfort to staff members at all levels and radically change their attitude towards priority-sector lending and help the banks to do a better job in this area of banking. 

- The farmer community in our country requires a lot of counseling and the bank officers engaged in this activity should be trained in this art of providing advice and counsel whenever needed and consider the requests of the borrowers with a humane touch. 

Concluding Remarks:

The shrinking share of real priority sector, neglect of agriculture, falling number of accounts across the different categories of priority sector, loan recovery mechanism etc are some of the serious issues which need immediate attention of the policy makers. The overall analysis on priority sector advances by commercial banks is based on the sectoral growth of the economy as a whole. However, the analysis of priority sector NPA dampens the banking industry to make radical changes on improving the share of credit to neglected sector of the economy. Therefore, creating an appropriate and feasible strategy for disbursal and repayment is an imperative step for future work and, as such, would make an important contribution to this pivotal field.

It is expected that the new norms and measures defined under priority sector lending would not only facilitate the banks to improve the share of priority sector lending substantially but also hitherto opened several avenues to disseminate credit for genuine growth and development of the disadvantaged sections of the society enabling them to move forward along the mainstream.


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