All you wanted to know about PSL certificates

Whenever they’re severely bitten by the NPA bug, Indian banks have this tendency to turn risk averse. So how do the powers-that-be ensure steady flow of credit to needy sectors such as agriculture, housing, education and micro/small enterprises that keep the economy chugging? The RBI listing out ‘priority’ sectors that banks must compulsorily lend to, has been one traditional method. But with this method often criticised for meddling too much in the workings of banks, banks have been allowed an escape hatch. Enter PSL certificates!

Priority Sector Lending Certificates (PSLCs) are instruments that enable banks to achieve their priority sector lending targets without actually disbursing loans to sectors outside their comfort zone. PSL certificates allow banks sitting on surplus loans to a priority sector to sell certificates to banks that haven’t met their targets, pocketing a sizeable fee for this trade. The said loans however do not change hands.

The RBI mandates banks to lend a minimum of 40 per cent of their total loans to priority sectors such as agriculture, education, social housing, and micro enterprises. Aside from the overall target, banks are also required to meet sub-targets within this, such as 18 per cent towards agriculture (8 per cent for small and marginal farmers), 7.5 per cent for micro enterprises and 10 per cent for weaker sections.

While banks almost always meet the overall target, keeping up with the sub-targets was getting difficult for banks with limited expertise in certain sectors. Also, banks were sceptical about operating out of their niche, fearing poor loan judgments and dents to their profits. Earlier, in the event of a shortfall in any specific category, banks had to make good this shortfall by either buying out such priority sector loans (in full) from other banks or had to pay a penalty to the Rural Infrastructure Development Fund (RIDF).

However, from April 2016 onwards, the RBI launched an online trading platform — the PSLC platform — to allow banks to trade in PSLCs to meet the sectoral sub-targets. Rather than offering fresh loans, banks were only required to hold PSLCs reflecting lending by others.

Not only were the costs involved limited to the fee on the certificates, but trading in the certificates also helped curb their risk exposure. Further, the online trading platform ensured that the fee on PSLCs was market driven, based on the demand and supply in each category.

Like other businesses, banks have their specialisations too. Not all banks are good at lending to every category of borrower. Buying PSLCs allows banks not familiar with a certain category of borrowers to leave the lending to others and meet their PSL requirement without having to take the risks on their books. Similarly, banks that are over-achievers in a certain category can cash in on their achievements over targets.

According to the RBI’s Trends and Progress in Banking, in 2018-19, the total trading volume of the PSLC platform surged by 78 per cent to ₹3.27 lakh crore as on March 31, 2019. Going by the data on PSLC trading in the annual reports of individual banks, it appears that trading in PSLCs has gone up further in FY20. With overall credit growth in the sector slowing considerably in FY20, priority sector lending too has taken a hit. Growth in overall priority sector loans stood at 5.8 per cent in FY20, with a sharp slowdown in housing (4 per cent) and agriculture (3.8 per cent).

With falling interest rates, banks are keen to protect their margins, and hence are more likely to resort to buying PSLCs. For a priority sector borrower though, this means that credit availability may not rise any time soon, despite the many tools deployed by the RBI.

Banks can buy their way into the policymakers’ good books.

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