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C. L. Dadhich

AGRICULTURE and tiny and village industries sectors need most attention. They not only provide employment to large numbers of people, but an overwhelming chunk depends on these sectors for its livelihood. The financing of these sectors has been an overriding priority of banks, particularly after nationalisation. But since the introduction of the financial sector reforms, financing of these sectors, in general, and small borrowers, on particular, has been seriously affected.

The share of direct agricultural finance to total advances fell sharply from 10.1 per cent as at end-March 1995 to 7.2 per cent as at end-March 2002. Similarly, advances to artisan, village and tiny industries, which constituted 0.5 per cent of the total bank advances, declined sharply to 0.1 per cent during the period under review.

Within the farm sector, the share of small borrowers for direct agricultural loans fell sharply from 89.1 per cent at end-March 1995 to 77 per cent at end-March 2002. The fall was pronounced in the credit limit/loan bracket of Rs 25,000 and less, which declined from 59.5 per cent to 34.3 per cent during the period under review.

Similarly, the share of small borrowers belonging to artisans and village and tiny industries fell sharply from 99.9 per cent in 1995 to 29.8 per cent in 2002. The fall in the share of very small borrowers with credit limit up to Rs 25,000 belonging to this segment was more alarming, declining from 91.4 per cent at end-March 1995 to 16.1 per cent at end-March 2002.

A number of policy measures are directly or indirectly responsible for this. Important among these are the partial decontrol of interest rates of the commercial banks, on the one hand, and total deregulation of interest rates in co-operative and regional rural banking sectors on the other.

Interest rates of commercial banks were deregulated for the credit limits/loans over Rs 2 lakh with effect from October 1994, while interest rates up to Rs 2 lakh were stipulated at not exceeding PLR of the bank concerned. Further, the total deregulation of interest rates of co-operative and regional rural banking sectors has made agricultural credit costlier, in general, and in the areas of monopoly of these sectors, in particular. Small borrowers in the service area of Regional Rural Banks have to pay higher interest rates compared to their counterparts in the service areas of commercial banks.

Not that partially deregulated interest rates are only responsible for this state of affairs. The other reform measures have also affected the interest of the small borrowers. The introduction of the prudential norms, particularly those relating the asset classification, income recognition and provisioning, has made the banks more cautious in financing small borrowers, who (as per bank perception), are riskier and may contribute to the NPA level.

The relaxed collateral norms have also added fuel to fire. The tightening of prudential norms and the relaxed collateral norms cannot go together. Either it has to be relaxed collateral norms to augment the flow of credit or stricter prudential norms to improve the financial health of the banks.

While relaxed collateral norms are injurious to the financial health of the banking system, the tightening of prudential norms is a stumbling block to the smooth flow of credit to the small borrowers as it exerts pressure on the banks to be over-cautious.

Thus, banks generally avoid financing of small borrowers. It is interesting to note that the limit for non-obtention of collateral security is Rs 10,000 for agricultural term loan where movable asset is not created and Rs 25,000 for agricultural term loans where movable asset is created. The limit for non-obtention if collateral security is also Rs 25,000 for crop loans. The limit for non-obtention of collateral security is as high as Rs 5 lakh for tiny and SSI units. Furthermore, under the Credit Guarantee Scheme for small-scale industries, the guarantee cover is as high as Rs 25 lakh for the loans extended by commercial banks without taking collateral security.

Similarly, borrowers under the Prime Minister's Rozgar Yojana (PMRY) are eligible for exemption from obtention of collateral security for loans of Rs 1 lakh.

Under relaxed collateral dispensation, banks have to entirely depend on primary security and on the integrity of the borrower. Quite often, these are not sufficient. On the other end, cronies benefit from the relaxed collateral norms.

There is a growing tendency among the borrowers to wilfully default in the absence of adequate collateral. Collateral is an insulation against default. To reinforce repayment culture and arrest the growing tendency of wilfull default, it is necessary to insist on adequate collateral for bank loans.

Apparently, relaxations in collateral norms are counter productive and there is a case for rationalisation and tighten the collateral norms to augment the flow of credit to needy sectors. However, genuine entrepreneurs not having any collateral to offer may be encouraged to form self-help groups to provide at least social collaterals in the form of joint liability. The tightening of collateral norms will provide much needed comforts to banks and will go a long way in augmenting the flow of credit. This will discourage demand for credit by cronies and to promote repayment ethic.

Further, it is imperative to deregulate the interest rates on loans over Rs 50,000 if not on all loans. The Centre's decision to advise public sector banks to provide crop loans up to Rs 50,000 is a step in the right direction, but it should be extended for term loans and to encourage the small borrowers to invest in agriculture. Banks should be given freedom to charge interest rates on loans over Rs 50,000. The measure will protect the interest of small farmers/borrowers, on the one hand, and will encourage banks to augment flow of credit to needy sectors, on the other. Those taking a loan over Rs 50,000 may not be poor and, therefore, should be charged the commercial rates. To ensure competition in rural lending, it is necessary to scrap the present system of service area approach; this is not possible, it should be only for government-sponsored programmes.

Tightening of collateral norms, full deregulation of interest rates over Rs 5,00,000 loans and scraping of the service area approach will go a long way in augmenting the flow of credit to the needy sectors, on the one hand, and providing comfort to the banks, on the other.

(The author is a former Director in the Department of Economic Analysis and Policy of the RBI.)

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