K Kanagasabapathy

Redefine priority sector lending

| Updated on: Nov 08, 2012

Priority sector lending must be reoriented to promote growth, infrastructure and employment, leaving equity to financial inclusion initiatives .

Statutory pre-emptions of funds in Indian banking in the form of cash reserve ratio (CRR) and statutory liquidity ratio (SLR) arise on considerations of prudence, monetary policy and liquidity requirements, besides carving out a captive market for government securities. However, a third pre-emption in the form of directed credit is rooted primarily in the concept of priority sector lending (PSL).

The governing considerations behind PSL were partly economic and developmental, with the objective of aligning credit flows with Plan priorities, and partly social, to ensure employment growth and equitable distribution of credit, particularly among small and vulnerable groups of population.

The PSL norms were also intended to compensate for inadequacy of budgetary resources to finance such activities directly by the government. Therefore, PSL also represents a form of quasi-fiscal operations of the government. The origins of PSL can be traced to social control of banks initiated in 1968 through amendments to banking laws, but culminating in the crucial political decision of nationalisation of major commercial banks in July 1969.

We try to address three aspects of PSL — first, the level; second, the economic or sectoral dimensions and scope; and third, the social and equity aspects. We argue that a new approach to PSL is needed if it is to serve its intended purposes.

Complex Dimensions

The level is an administrative decision, but it has to be based upon what the traffic can bear and also what target sectors/groups are covered. The pre-emption level originally was one-third of total net bank credit (NBC) in the 1970s, but later was revised to 40 per cent of NBC in early 1980s. The total pre-emption of banking resources, including PSL, of about 70 per cent now looks too much indeed in a liberalised financial regime.

The Narasimham Committee of 1991, which went into the issue of directed credit, observed after drawing attention to the problem of low and declining profitability, that there was a need for gradual phasing out of the directed credit programme, and that the proportion should be fixed at 10 per cent of the aggregate credit to cover the really needy and poor.

This recommendation was not heeded by the Reserve Bank or the government. A similar approach for redefining the sub-targets was made by the recent Nair committee, stressing the need for flow of credit to small and marginal farmers and micro enterprises. This also went unheeded.

The original thrust was given to agriculture, small industries and exports, with additions of small road and water transport operators and self-employed, which was sustained till the late 1980s.

But, this thrust has been completely diluted because of demands of the banking system to sustain its profitability and meet tighter prudential standards since the beginning of 1990s.

What is more pertinent is that the framework defining the sector’s dimensions and scope and the quantitative norms for measuring compliance by banks have undergone metamorphic changes since its inception, rendering the concept rather kaleidoscopic.

Another dimension is that the prescriptions are specific to particular class of banks, in particular public sector, private and foreign banks. In spirit, because of its social purpose and its quasi-fiscal nature, public sector banks bear the brunt of such pre-emptions, explicitly or implicitly.

The problem with the present priority sector guidelines is its multiple and complex categorisation, incorporating several objectives, viz, growth, employment, and equity.

There are sectoral classifications combined with beneficiary-oriented categorisation. The added complexity also comes from bifurcation of direct and indirect financing under major categories. Since there is an overall target, despite sub-targets, and because of complexity of categorisation, banks are able to comply with priority sector norms, effectively diluting the thrust of policy over direct credit. The new base of adjusted net bank credit (ANBC) also overstates compliance with PSL compared with the earlier NBC.

Need for a new Approach

The PSL guidelines incorporated in the master circular updated up to June 2010 were reportedly an amalgamation of about 22 circulars issued from 1977 onwards. After the recent Malegam report and M.V. Nair’s report, this has undergone further complex changes as late as up to September 2012.

Despite the avowed intention of banking outreach and touching vulnerable groups of population, priority sector targeting, as per the present framework, has left the major part of the population untouched. This has led to the parallel development of new policy initiatives in financial inclusion and gaining of momentum of alternative credit delivery models such as the microfinance movement. These changes have not been recognised and integrated into the approach towards PSL.

It is imperative that the priority sector should be redefined more from the standpoint of growth and employment, and the equity angle should be left to be best served through the policy of financial inclusion. Mostly, it could include sectoral classification, leaving the beneficiary oriented groupings to be served by financial inclusion strategy.

If one follows this principle, infrastructure financing should gain a significant priority and innovative ways should be explored to allow the banking system to finance infrastructure, while agriculture and micro enterprises should continue to receive attention.

But, the level and sub-targets should be rearranged to cover really the vulnerable groups as recommended by the Narasimham committee, and recently by the Nair committee. It is not the medium and large farmers who commit suicide but the small and marginal ones. It is not the small and medium enterprises as a whole that suffer constraint of credit but it is mostly, as the economic census shows, the micro enterprises.

Growth and Equity Angle

Directed credit also implicitly gave a continued life to the operation of credit channel of monetary policy, along with increasing prominence of the interest rate channel since the reforms of 1990s. But, the priority sector guidelines, which form the basis of exercising this policy, have lost their initial thrust both from growth and equity angles. Reprioritisation is expedient also from the angle of minimising the adverse shocks emanating from monetary and external shocks and to ensure credit flow to really vulnerable groups.

The sacrifice of growth for containing inflation and the cost of correcting adverse redistributive effects of inflation need not be that large, if reprioritisation of directed credit is strategically attempted.

(The author is Director, EPW Research Foundation. Views are personal)

Published on March 09, 2018

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