Time to do away with priority lending norms
Foreign banks with more than 20 branches in India will now be required to extend a portion of their loans to small and marginal farmers as well as micro enterprises from fiscal year 2018-19, as per the respective sub-sectoral targets. Those with less than 20 branches will also need to fulfil the overall PSL norms of 40% of adjusted net bank credit (ANBC) in a phased manner by 2020.
However, foreign banks have cited their lack of knowledge, and fear of stressed assets, as reasons for their reluctance to lend to these sectors.
The impact of priority sector loan targets on banks’ credit risk management strategies in India has been commented upon by the International Monetary Fund (IMF).
In a recent report (https://goo.gl/wzhSZv), the IMF, raising concerns regarding the role of the public sector in the financial system, has advised the RBI to review its PSL policy to allow for greater flexibility in meeting targets. It also suggests a gradual reduction in PSL as a means to move funds into “more productive activities”, and greater participation of the private sector in capitalizing public sector banks, together with full capitalization.
What is the truth? Are PSL norms responsible for banks’ stressed assets? Is there a business case for greater flexibility in targets for PSL, if not a complete removal of PSL norms?
A perusal of the RBI’s Trend And Progress Of Banking In India reports over the last decade reveals that public sector banks have been continuously underperforming on the total priority sector target of 40% since 2012, while private sector banks have continuously lent more than the mandatory target of 40%, except for two years. Foreign banks also outperformed their mandated target of 32% throughout the decade till 2015-16, as well as the higher targets required later.
However, all banks have defaulted on their sub-sectoral targets, especially that of 18% for agriculture, in most years.
This appears strange, since paradoxically, priority sector loans have contributed far less to the gross non-performing assets (NPAs) of all three categories of banks than non-priority sector loans. In fact, public sector banks had a large proportion of NPAs among their priority sector loans (50%) in 2012, a figure that had come down to 24.1% in 2017. Non-priority sector loans contributed to 82% of NPAs in the case of private sector banks in 2017, against the 18% of NPAs in the case of priority sector loans. Foreign banks had a comparable figure for NPAs within their non-priority loans.
Thus, priority sector lending may not be responsible for compromising banks’ credit risk minimization strategies, or risk accumulation. Yet, most bankers seem reluctant to lend to the priority sectors.
An informal chat with bankers reveals that the problem with priority sector loans is the lack of understanding of the sub-sectoral target groups, especially agriculture and the small and medium sector, as also weaker sections. A foreign bank, desirous of opening a bank branch in some remote area to service agricultural borrowers, neither understands its borrower, nor is clearly aware of the legal provisions to recover stressed assets.
Further, given the vagaries of the monsoon that agriculture is susceptible to and the undiversified risk portfolios in such rural areas, the credit risks for such banks from such PSL would be extremely high.
The same would be the case for PSL to the micro, small and medium enterprise (MSME) sector. The sector, with its unorganized operations and lack of proper accounting records and financial statements, poses higher costs and greater risks in credit disbursement.
Little wonder, then, that foreign banks have exhibited a reluctance to extend their bank branches, with the number of foreign bank branches in India falling to 286 on 31 January 2018, compared to 317 in FY 2016.
Thus, while priority sector lending, by itself, may be seen as serving the purpose of directed credit within a developing country like India, there appears to be a genuine business case for allowing flexibility in sub-targets for various categories of bank priority sector lending.
Banks should be allowed to choose the category they wish to lend to. Foreign banks may then choose to lend in the form of export credit (which was a sub-sectoral target for foreign banks prior to 2012, and was later removed), rather than to agriculture.
Similarly, private sector banks may choose to lend housing credit in urban areas, rather than being forced to lend agricultural finance. The government may rely on specialized institutions such as the National Bank for Agriculture and Rural Development (Nabard) to fulfil sectoral lending targets, while at the same time ensuring structural reforms in these sectors to make lending to them more viable.
It is time the banking sector in India is allowed to grow its balance sheets, and do business the only way that it ought to be done, namely, with reference to bottom lines.