Meeting priority sector lending shortfalls: One more option

Aanchal Kaur Nagpal, Manager | finserv@vinodkothari.com

Background

All scheduled commercial banks (including Regional Rural Banks and Small Finance Banks) are required to undertake priority sector lending. RBI mandates PSL to account for at least 40% of a bank’s Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off‐Balance Sheet Exposure whichever is higher, in accordance with the RBI PSL guidelines[1].

The intent behind prescribing PSL limits for banks is to enable certain sections of the society, though fairly credit-worthy but unable to obtain credit from the formal financial/ banking system, to access adequate credit. These sectors do not seem to be economically lucrative but are indispensable for the overall development and growth of India’s economy.

Each of these broad sectors also have sub-targets that are to be achieved on an annual basis.

Spending and Shortfall 

The priority sector lending (PSL) for scheduled commercial banks (SCBs) stood at 42.8 per cent as on March 31, 2022. All bank groups achieved the prescribed PSL target of 40 per cent during 2021-22[2].

All banks typically achieve their overall PSL target, however, shortfalls are usually witnessed in certain sub-targets. While public sector banks have shortfall in micro enterprises, private banks have shortfall in lending to small and marginal farmers, as per ICICI Securities Report. 

Nevertheless, meeting PSL targets has always been a challenge for several banks, particularly those not with a strong retail branch network, given the fact that PSLs are mostly small-ticket loans and involve costly origination and specialized recovery procedures. Banks lack either the outreach or the inclination towards exposures to such kind of lending

Further, since such sectors are riskier than traditional productive borrowing sectors, there is a higher probability that such loans do not perform. A lack of financial literacy also acts as a deterrent for such sectors to avail formal credit and place reliance in local money-lending. 

Bridging the shortfall 

Where Banks are unable to lend and meet the PSL targets on their own, they lean on other ways to make good the deficits. RBI has even recognised various modes through which the same may be done:

1. Co-lending/ co-origination with NBFCs

Banks enter into lending partnerships with other financial entities, and leveraging on the origination capabilities of the partner they take an exposure on PSL sector. In these co-lending partnership, there is a risk and reward sharing, as well as the various functions involved in the lending process are allocated between the co-lenders. Thus, by virtue of the co-lending arrangements, the banks are able to meet their PSL targets to the extent of their share in the loan. 

2. Lending to NBFCs for on-lending 

NBFCs have better customer outreach in the areas which fall under the category of PSL, such as agriculture and MSMEs. Thus, by providing them the funding with specific end use restrictions and terms of lending, banks may ensure an indirect exposure in the PSL sector. Though the on-book exposure by the bank is on the NBFC, however, the underlying loans are extended to the priority sector and hence, provides benefit to the bank for meeting PSL targets. There is also a cap on the quantum of on-lending to NBFCs (except MFIs) that would be eligible for PSL categorisation.

3. Specified Deposits with institutions

Banks are allowed to invest in Rural Infrastructure Development Fund (RIDF) bonds issued by the Small Industries Development Bank of India and the National Bank for Agriculture and Rural Development (NABARD) to offset the shortfall in achieving the targets. 

As per NABARD report, PSL shortfall deposits swelled from Rs 99,000 crore in March 2021 to Rs 2.52 trillion in March 2022. 

4. Investment in Priority Sector Lending Certificates 

As per RBI data, the total trading volume of priority sector lending certificates (PSLCs) registered a growth of 12.4% and stood at Rs 6.62 lakh crore at the end FY22. Amongst the four PSLC categories, the highest trading was observed in PSLC-General and PSLC Small and Marginal Farmers.

5. Securitisation and Direct Assignment

Investments by banks in securitised assets or through direct assignment/outright purchase of a pool of assets, representing loans by banks and financial institutions to various categories of priority sector, except ‘others’ category, are eligible for classification under respective categories of priority sector depending on the underlying assets. NBFCs, specifically MFIs, operating on low-cost origination structures and having greater retail accessibility and  outreach, have  usually been feeders to banks for their PSL shortfalls. 

6. Inter Bank Participation Certificates (IBPCs)

IBPCs purchased by banks, on a risk sharing basis, are eligible for classification under respective categories of priority sector, provided the underlying assets are eligible to be categorized under the respective categories of priority sector and the banks fulfil the prescribed conditions. 

Budget proposed additional avenue for meeting the deficit 

The Budget has proposed an additional avenue for PSL shortfall, similar to RIDF, an Urban Infrastructure Development Fund (UIDF) which shall be funded through such PSL shortfalls. The same shall be managed by the NHB for creating urban infrastructure in Tier 2 and Tier 3 cities through public agencies. It is expected to raise funding of around Rs. 10,000 crore per annum for this purpose.

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[1] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11959

[2] As per RBI Annual Report – https://rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/0RBIAR2021226AD1119FF6674A13865C988DF70B4E1A.PDF