Why priority lending certificates won’t sell

If the Reserve Bank is to be believed, the new guidelines on buying and selling priority sector lending certificates (PSLCs) would enhance lending to the categories under the priority sector by further incentivising banks.

According to the new guidelines, banks unable to meet their priority sector lending (PSL) targets and sub-targets can buy PSLCs issued by the banks that have over-achieved their targets. Accordingly, banks can issue four kinds of PSLCs — agriculture, small and marginal farmers, micro-enterprises and those issued for overall lending targets.

Thus, a bank not meeting any sub-targets will have to buy the specific PSLC to meet its goal. As the bank’s PSL achievement would be computed as the sum of outstanding priority sector loans, and the net nominal value of the PSLCs issued and purchased, there will be no transfer of loan or risks. The buyer would pay a fee to the seller, which will be market determined.

The central bank is reported to have advanced the argument that PSLCs will drive priority sector lending by leveraging the comparative strength of different banks. For example, a bank with expertise in lending to small farmers can over-perform and earn benefits by selling its over-performance through PSLCs; another bank (better at lending to small industry) can buy these certificates while selling PSLCs for, say, micro-enterprise loans.

Currently, all banks with 20 branches or more must lend at least 40 per cent of their total loans — adjusted net bank credit, or ANBC — to priority sectors. They also have to meet sub-targets such as 18 per cent for agriculture, 7.5 per cent for micro-enterprises, and 10 per cent for weaker sections. However, the analysis of performance of public sector banks reveals that the shortfall from the targeted level of 18 per cent for all PSBs ranged between 2.5 to 3.5 percentage points between 2001 and 2007.

Though the target level of 18 per cent was virtually achieved between 2008 and 2010, the period afterwards — 2011-14 — witnessed a decline in the share of agriculture in total advances. The performance of private sector bank in terms of meeting agriculture targets was even worse.

Further, more than half the PSBs (16 of 26) couldn’t achieve the 18 per cent agriculture target in 2014, while 13 of the 20 private sector banks failed to achieve sub-targets for agriculture.

Also, the over-performance by some banks in terms of meeting agriculture target was not enough to meet the shortfall of others.

Given this scenario, the argument put forward by the central bank with respect to the purchase and sale of PSLCs to achieve sub-targets by respective banks becomes irrelevant. Unless all the banks taken together are able to achieve the target of 18 per cent or more, a re-distribution by the purchase and sale of PSLCs will not help all the banks in meeting targets. Further, allowing banks to meet their priority sector targets and sub-targets by buying PSLCs would deprive thousands of farmers from the opportunity to avail bank credit.

Many banks find it difficult to meet their PSL requirement as they find lending to priority sector a losing proposition, owing to the higher transaction cost of financing a large number of small-sized loans involving higher credit risks.

Under the new system, since the buyer has to only pay a fee to the selling bank, its margin will not be impacted on account of buying out lower-yielding priority sector loans (as is the practice currently), and the fee paid will be treated as expense in the books of the buying bank; therefore, it may turn out to be a good business proposition for banks scrambling to meet their targets.

Hence, it won’t be a surprise if the shortfall continued unabated. With the shortage in meeting PSL targets going up, the demand for PSL certificates would also rise.

Finally, as in the past, the RBI move is in continuation of its strategy to facilitate the banks to achieve the same quantitative targets without compromising the profitability of the business.

Consequently, over the years, the priority sector credit has become just a set of numbers regularly modified by the RBI; it lacks focus and rationality. In India, where out of the 140 million farm families only 50 per cent have access to institutional credit, the PSLCs scheme would cause more damage to distributional justice.

The writer teaches at National Institute of Bank Management in Pune. The views are personal

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