Banks unable to meet their priority sector lending targets now have a more viable and easier way to make good their shortfall. The RBI recently issued guidelines for purchase and sale of priority sector lending certificates (PSLC) through a portal. Since the buyer bank will only pay a fee to the selling bank, margins will not be impacted on account of buying out lower yielding priority sector loans, as is the practice currently.

All domestic and foreign banks with at least 20 branches are required to lend a minimum of 40 per cent of their total loans [Adjusted Net Bank Credit or credit equivalent amount of off-balance sheet exposure (whichever is higher)] to the priority sector (agriculture, micro enterprises, education, social housing, etc.). They are also required to meet sub-targets such as 18 per cent for agriculture (8 per cent for small and marginal farmers), 7.5 per cent for micro enterprises and 10 per cent for weaker sections. The RBI has now permitted banks to buy PSLCs issued by banks that have over-achieved their targets. There will be four types of PSLCs — agriculture, small and marginal farmers, micro enterprises and general. The first three can be utilised for meeting sub-targets for lending to a specific sector.

Trading competencies

Many banks find it difficult to meet their PSL requirement as they may not find it viable to lend to the rural or MSME sector. In case of a shortfall, they either have to buy out such priority sector loans from other banks and financial institutions or contribute to the Rural Infrastructure Development Fund (RIDF).

The trading of PSLCs will help banks overcome multiple challenges they currently face. For one, it offers banks a seamless platform to buy and sell their priority lending targets. A bank that is focussed on priority sector lending say, agriculture, now has the flexibility to issue and sell certificates with ease in the secondary market. For instance, Central Bank of India while meeting its overall target of 40 per cent for 2014-15 (as per annual report), also fulfilled its sub-target for agriculture, lending 19 per cent of loans to this segment. On the other hand, ICICI Bank, which was able to meet its overall PSL requirement, gave out 12 per cent of loans to agriculture against the 18 per cent requirement. Banks can now trade PSLCs in specific categories to make good the shortfall.

No grossing up

Aside from providing a liquid secondary market for such papers, the new system offers more operational flexibility to banks. Earlier, when a bank fell short of its target, it had to buy out such loans from others, which essentially meant an increase in the buyer bank’s balance sheet.

These priority sector loans were grossed up — added to the existing loan book — for computation of PSL requirement for the coming period. Hence the burden of banks falling short of their requirement time and again only increased, according to bankers.

But now a bank can buy certificates from another bank to fulfil its requirements without taking on the loans in its books. According to RBI’s guidelines, a 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 loans.

Priced based on demand

The payment which a buying bank has to make for the PSLCs will be market determined. The price could depend on a host of factors such as the category of loans and demand and supply scenario. Some bankers feel that the fee could range between 4-5 per cent of loans, but it is still early days to put a number to it as price discovery will happen over a period of time. One-off events can push up the premium of such certificates too. For instance, in case of a disastrous monsoon season, as banks turn risk averse to lending to the agri sector, demand for PSL certificates would go up, and hence they may sell at a premium. The amount paid to acquire PSLCs will be treated as expense in the books of the buying bank.

Earlier, if a bank bought out Rs 100 crore of priority sector loans, the cost was essentially the opportunity loss. Banks usually earn a lower 5-6 per cent on priority sector loans as against 10-11 per cent on other loans. Hence, 5-6 per cent would be the implied cost of buying such loans. For a buying bank, these were low-yielding loans, which impacted margins. Now, under the new system, it will only be a cost. So margins may not drop.

For a seller bank too, the income from sale of PSLCs will be treated differently. Earlier when a bank sold its loans earning say 5 per cent, and deployed those funds for lending to the non-priority sector for 10 per cent, it made a net interest income of 6 per cent on such loans. Now, this income would be treated as ‘miscellaneous income’.

Finally, banks scrambling towards the year-end to meet their targets may become a thing of the past. Now, according to RBI guidelines, a bank is permitted to issue PSLCs up to 50 per cent of the previous year’s PSL achievement without having the underlying loans in its books. However, as on the reporting date, the bank must have met the priority sector target.