Redefining Priority Sector Lending

In December 1967, the then Finance Minister Morarji Desai introduced a new term for bankers, the “Priority Sector” and this term has come to stay in the Indian banking terminology since then. The challenges for the Indian banking sector in the 1970’s and 1980’s were formidable and in response to the national requirements, the RBI set up three major Committees which responded to D R Gadgil’s reasoned observations as Member of the Planning Commission, as under:

1. F K F Nariman Committee, 1969
2. R K Hazari Committee, 1971
3. K S Krishnaswamy Committee, 1985

The Indian economy has witnessed momentous and dynamic changes since 1947 and the contributions of the Primary (Agriculture) sector, the Secondary (Industries) sector and the tertiary (Services) sector to the country’s Gross Domestic Product (GDP) have varied over the last 65 years.

Today, agriculture contributes 14 per cent to the country’s GDP but employs 52 per cent of the labour force. Rapid growth in the rural markets, transportation, mobile communication, etc, has enabled the services sector to contribute over 66 per cent to the country’s GDP while the industrial sector contribution has been languishing at 17-20 per cent over the last 40 years despite generous hand-outs and continuous incentives to the sector. The Priority Sector Lending (PSL) flow since 1969 reflects this bias of the banking system.

Economic Reforms since 1991

With the LPG (Liberalisation, Privatisation, Globalisation) reforms initiated under duress since 1991 and the effect of the Reagan-Thatcher regime on economists in the 1980’s, there has been a trend to spout the World Bank views even though the World Bank/International Monetary Fund admits to serious prescription failures for various countries (between 1970 and 2000) when they erred in about 60 per cent country-specific economic prescriptions. For China and India, the IBRD prescriptions were quietly ignored and this wise decision enabled their economies to grow till 2010. The RBI, however, has been setting up Committees which reflected the World Bank-directed views as under:

1) C Narasimhan Committee, 1991
2) M V Nair Committee, 2011
3) N Mor Committee, 2014

While the earlier RBI Committees talked about redistributive justice and growth with equity and ensured that the bank nationalisation phase since 1969, ensured financial inclusion and a way out of poverty for the really poor with the Antodaya and Integrated Rural Development Programmes, post-1991, the RBI Committees have started distancing the banks from their priority sector obligations and have turned a Nelson’s eye to the scheduled commercial banks which do not meet their priority sector obligations year after year without penalising them. As for the private sector banks, their doctored data relating to priority sector loans were duly accepted by RBI without batting an eye-lid. The Narasimhan Committee wished to reduce mandated priority sector lending to 10 per cent of bank credit outstanding, while the Nair Committee wished to do away with the Differential Rate of Interest Scheme. The Mor Committee’s recommendations are even more radical as it desired to make priority sector lending so complicated with weights, specialised banks and incentivised lending to the credit-deprived sections of the society and regions thereby theoretically increasing PSL to 50 per cent from the 40 per cent cap imposed since long. The Mor Committee recommendations are actually intended to make the PSL norms unworkable and non-implementable so that RBI can then bring down officially the curtains on this entire PSL episode once and for all.

The Priority Sector Lending norms for all scheduled commercial banks are simple with 40 per cent of net bank credit to flow to the desired sectors such as agriculture (18 per cent), MSME sector, small business/enterprise, micro-credit, education and housing sectors.

Dilution of PSL norms

The Priority Sector Lending norms for all scheduled commercial banks are simple with 40 per cent of net bank credit to flow to the desired sectors such as agriculture (18 per cent), MSME sector, small business/enterprise, micro-credit, education and housing sectors. While it must be acknowledged that the priorities and challenges of the 1970’s and the 1980’s are not the challenges in 2015, the rural economy continues to languish amid mass poverty, infant and maternal deaths and malnutrition despite a plethora of schemes/programmes/plans at various levels. If the World Bank economists are to be believed, 74 per cent of our population in 2012 is below the Poverty Line (defined at $2 spent per diem). Doing away with the PSL scheme will not do away with poverty and hunger in large under-developed regions of the country.

Is it proper for well-fed and rotund bankers to distance themselves from the grim realities of poverty, malnutrition and hunger in rural India? With the widening wealth-gap between the well-off and the famished, social unrest is bound to increase and there is no magic wand to remove poverty. With many new banks waiting in the wings for licences, there is a vested interest in doing away with or diluting the Priority Sector Lending norms. Instead, let us resolutely accept the challenges which are posed by the Indian banking sector and the economy today and divert the flow of funds to the neglected and weaker sections of the society. To dilute the PSL norms further today would only exaggerate and even accelerate the existing social tensions.

Banks are business entities and have to ensure profitability, control NPAs, implement online banking, set up ATMs, consider Risk/Asset Liability Management, Basel-III norms, improve efficiency and productivity and manage to be competitive by ensuring efficient customer services.

Monitoring Requirements

Banks are business entities and have to ensure profitability, control NPAs, implement online banking, set up ATMs, consider Risk/Asset Liability Management, Basel-III norms, improve efficiency and productivity and manage to be competitive by ensuring efficient customer services. All of these have costs attached but the banks also have a duty to society at large. So, banks must adhere to the PSL norms with RBI monitoring this strictly. Erring banks and bankers should be penalised if they fail to achieve norms. Bankers routinely complain that there are no rural projects worth financing. Another major problem is that no farmer maintains an income-expenditure statement or profit-loss account and is unable to satisfy the banker’s demand for farm accounts which can justify the crop loan amounts. Another problem is that crop loans are heavily subsidised both by the Central/State governments through banks and some States have zero per cent crop loans (MP, Karnataka, etc.)for prompt repayment of crop loan dues. As money is fungible, farmers divert crop loans for purchase of farm assets which carry interest rates of 12-14 per cent and avail of subsidised crop loans from banks. The banks also contribute to this mess by failing to monitor agricultural loans and prevent diversion of funds.

Banks need a simpler regulatory framework based on transparent policies and processes with emphasis on self-declaration and strong penalties for aberrant behaviour and false reporting. The weightage-based scheme and incentives advocated by the Mor Committee are basically unwieldy and unimplementable. There is a need to simplify reporting procedures and also impose deterrent penalties for misreporting which is common when banks do not achieve their targets. The reporting and monitoring systems will operate at the district level with the Lead Bank’s monitoring at the district and state levels while RBI could monitor the bank-level targets. The district-level monitoring mechanism will be the District Credit Plan Implementation Committee (DCPIC) and will comprise the following:

1. District Collector-Chairman
2. Project officer, DRDA
3. District Development Manager, NABARD
4. Lead District Manager, Lead Bank–District Convenor

The DCPIC will meet twice a year to review the April-September credit disbursements and the October-March credit disbursements. Basically coordination between banks and the Government agencies, NGOs and corporates and other stakeholders will be discussed. The DCPIC will also monitor the credit-deposit ratio for all bank branches do not fall below 60 per cent (aggregated at district level).

Economic Challenges Today

The nation faces massive economic challenges which cannot be ignored and hence there is a need to redefine the priority sectors today.

1) Agriculture and Food Security (AFS limit–18 per cent)

There are 144 million agricultural labourers (30 per cent of the rural work force) without land and this is increasing due to the shrinking size of land holdings. 82 per cent of the farmers are smallholder with less than 5 acres of land and who find it increasingly difficult to maintain their families due to their shrinking margins. With climate change and global warming being ignored in India, food security issues are expected to crop up very soon. The number of cultivator-farmers has decreased by 9 million to 118.7 million in 10 years. If by 2050, 50 per cent of the population is urbanised, who is going to feed us? Will we repeat the bad experience of 1960’s? When we had the begging bowl for PL-480 are we seriously planning for food security? Only 11 per cent of our farmers have access to subsidised agricultural credit (effective interest rate for prompt repayment is 4 per cent or even less depending upon state government subsidies).

The 18 per cent agriculture sector PSL limit can be retained with a 2 per cent sub-limit for lending to joint-liability groups and another 3 per cent sub-limit for agricultural term-loans. Today, bankers tend to disregard the credit needs of oral lessees and tenant farmers and hence the need to encourage lending through Joint Liability Groups of farmers. Also bankers tend to dole out crop loans to farmers due to smaller loan amounts and reduced credit exposure averaging 6 months. With falling productivity levels (though production of foodgrains is rising), term credit needs of farmers are not being met especially with the Government of India refusing to cleanse and revive the Long-Term Co-operative Credit Structure (Vaidyanathan-II) since 2008. With reduction in term credit, farm investments leading to long-term productivity improvements, is possible. Crop loans are very short-term in nature and cannot enhance farm productivity.

2) Employment/Entrepreneurial Loans for Youth (EEY–18 per cent)

India is said to have a demographic advantage over other countries but with 400 million youth (between the ages of 10 and 24), there is a need for 12 million jobs every year. But with the economic downturn since 2010 and poor economic governance leading to drying up of corporate and foreign institutional investors, jobs have dwindled. Further with new technologies and processes and computerisation, job employment is reducing. With low population growth in developed countries, yet there is sharp rise in unemployment among youth giving rise to social tensions, violence and substance abuse. Job-led growth is a must for the youth so that their energies are channelised into productive and positive avenues. Loans given to those below 35 years for MSME, infrastructure and housing sectors will qualify for benefits under this sector.

As per a UNDP Report in 2005, the best development effort of any government would be to build roads and improve market connectivity and development activities continue under private initiative! The MSME sector contributes 7 per cent to GDP, 34 per cent to exports, employs 30 million people and can create manufacturing and marketing jobs for youth. Housing is another sector which can create jobs for youth and all micro-enterprises can be classified as “employment-oriented”. However there are a number of sick MSME units and this deters banks from placing more funds with such units. Reviving or nursing these units by loans to young engineers or entrepreneurs can be a viable option. Further, training, re-training and job-related activities can also be covered under this scheme. At least 33 per cent of the loans will be for women in this category and another 27 per cent for SC/ST beneficiaries so that social justice norms prevail.

In March 2015, an Internal Working Group Report of the RBI has reduced the sub-target of 9 per cent recommended earlier for smallholder farmers to 8 per cent as a subset of the 18 per cent credit flow reserved for agriculture and is diplomatically silent on the indirect agricultural credit component.

3) Financial Inclusion and Microfinance (FIM–2 per cent)

Almost 50 per cent of adults in our country have no bank account and hence before poverty alleviation or rural development is feasible, financial inclusion is a must. Women SHGs have done an excellent job by empowering poor women, channelising their irregular savings into micro-deposits and then ensuring micro-credit facilities in times of need and if possible they train them in various skills so as to create micro-enterprises, singly or jointly. Since 1992, there are now over 7 million SHGs (85 per cent women groups) with more than 100 million members which show the popularity of SHGs in India. The use of mobile phones in funds transfers and micro-credit is particularly welcome as it ensures better financial inclusion in rural India. 2 per cent of credit outstanding should be reserved for financial inclusion efforts and credit to SHGs. This will also account for the 2 per cent of profits to be earmarked for CSR efforts to be made by all corporates as per changes in the Company Act, 1955 with effect from 1st April 2014.

4) Differential Rate of Interest Scheme@4 per cent interest (DRI–2 per cent)

Two per cent of net bank credit outstanding at the end of the previous year should be for SC/ST beneficiaries only so as to help them set up small and micro enterprises in rural and urban areas. This will ensure credit availability to the weaker sections of the society on favourable terms. The RBI is keen to remove this facility as commercial banks are not keen on giving these interest subsidy loans and would like to do away with this scheme. Another anomaly is created by RBI in permitting sponsor banks of RRBs to add the DRI loans given by sponsored RRBs to the achievements of sponsor banks. A very strange dispensation given the fact that no such leeway is permitted by RBI for any other RRB loans.

Dogged Persistence

While it was a RBI Deputy Governor who first talked about the “Lazy Banking Concept”, one must comment on the dogged persistence of RBI in bringing in the concept of PSL Certificates. Let us examine its evolution. The Narasimhan Committee (II in 1998) first talked about the securitisation of debt certificates so as to purchase debt from financial institutions which are able to lend beyond the mandated percentage of PSL. This was plain speaking and must have been vehemently opposed as the RBI lay low on this issue for many years till the Nair Committee Report on PSL (2012).

Two of the Committee recommendations deserve mention. One recommendation was for non-tradable PSL securities on a pilot basis for all banks including RRBs and foreign banks. Another recommendation was a sub-target for small and marginal farmers at 9 per cent of the credit earmarked for agriculture (18 per cent under PSL). Then the RBI came out with the Nachiket Mor Committee Report (2014) which was a logical followup of RBI’s anti-farmer and pro-banker stance. It recommended for tradable PSL assets as of critical importance and regulations to enable banks to use risk-free PSL Certificates as a means to achieve PSL compliance among banks that wish to do so. Recommendations which are actually anti-farmerwere also made (Recommendations 4.28-4.31)

In March 2015, an Internal Working Group Report of the RBI has reduced the sub-target of 9 per cent recommended earlier for smallholder farmers to 8 per cent as a subset of the 18 per cent credit flow reserved for agriculture and is diplomatically silent on the indirect agricultural credit component. At a stroke of RBI’s venomous pen, smallholder farmers are being sought to be deprived of credit by recommending no caps for agri-infrastructure (including RIDF allotted targets for not attaining PSL norms) and agri-processing.

These recommendations are downright ridiculous and commercial banks are being advised by RBI how to ensure that agriculture loans need not be given to smallholder farmers but should be diverted to corporates and the secure RIDF loans are included as part of PSL achievements even though it is a default mechanism for non-achievement of PSL and agricultural lending targets. This shocking report should be challenged as it is yet another attempt by the RBI to reduce credit flow to smallholder farmers and should be opposed by all right-thinking people with all the emphasis at their command. Another recommendation is for the introduction of PSL Certificates which will enable banks to meet their PSL requirements even while leveraging their “comparative advantage” in lending. Talk about Double-Speak and even George Orwell must be turning in his grave!

The RBI game plan stands exposed and that is to ensure that banks need not soil their lovely NPAs further by lending to smallholder farmers and instead can push more credit to corporates and traders and real estate tycoons and create more NPAs and then write-off these loans.

Conclusion

The new priority sector norms will continue to be set at 40 per cent of credit outstanding as at the end of the previous year with 18 per cent credit flow for agriculture and food security. However many changes have to be incorporated to reflect the needs of the new economy and ensure new job creation, financial inclusion, besides ensuring credit availability for JLGs, SHGs, Women, SC/ST on favourable terms. The interests of smallholder farmers have been sacrificed to shore up the balance sheets of banks and the tragedy is that there is no pro-farmer lobby to challenge these RBI manipulations.