PSL is a legacy of the socialist era. It creates distortion in credit flows, keeps bank officials busy with target fulfillment and is prone to blatant misuse
Lenders, especially foreign banks have decided to undertake a comprehensive analysis of “sustainable finance” under the aegis of the Indian Banks’ Association (IBA) to make out a case for granting priority-sector lending (PSL) status to such financing for consideration by the Reserve Bank of India (RBI).
Globally, “sustainable finance” is broadly defined as any form of financial product/service that promotes environmental, social and governance purposes while contributing to the achievement of relevant targets adopted by countries under frameworks, including the Paris Agreement on climate and the Sustainable Development Goals (SDGs) set by the United Nations. Green power, green hydrogen, electric vehicles or other sustainability projects are prime candidates for such funding. What is the connection between “sustainable finance” and PSL? Why do banks want such funding to be treated as PSL?
PSL refers to a regulatory framework implemented by the RBI under which a certain portion of bank loans are directed towards specific sectors of the economy that are considered to be important for overall development and inclusive growth. Its origin dates back to 1966 when Morarji Desai then Minister of Finance and Deputy Prime Minister in Indira Gandhi's cabinet, recognized the need to increase credit to agriculture and small industries. A formal definition of PSL was established in 1972 based on a report by the RBI.
In 1974, commercial banks were assigned a target of 33.33 per cent of their Adjusted Net Bank Credit (ANBC) or credit equivalent of their Off-balance-sheet exposure (this includes contingent assets or liabilities such as unused commitments, letters of credit, and derivatives etc) whichever is higher to be given for PSL. Post - nationalization of fourteen banks (1969), Indira Gandhi, the Prime Minister at the time, found the PSL framework handy to address the demands of influential political groups.
Over time, the ambit of PSL was expanded to encompass other sectors such as micro, small, and medium enterprises (MSMEs), export, education, housing, social infrastructure, renewable energy and others such as self-help groups etc. The RBI has put in place a complex structure that provides for different percentages of PS lending for different categories of banks and further break-down into sub–categories (user-wise) within each.
For the dominant category i.e. commercial banks (including foreign banks with at least 20 branches in India), the PSL target is 40 per cent of ANBC. Within this overall limit, 18 per cent is meant for agriculture alone; within this, 8 per cent is to be given to small and marginal farmers (those who have a land holding of less than 2 hectares). The target for micro-enterprises is 7.5 per cent while weaker sections of society should get 12 per cent of these advances.
Although the guidelines do not lay down any preferential rate of interest for PSLs per se, generally such loans are “cheaper” and “more accessible.” The chargeable rate of interest is as per the RBI’s directives and varies from sector to sector.
A short-term crop loan of up to Rs 3,00,000 (for animal husbandry, dairy and fisheries farmers, this limit is Rs 2,00,000) is available at a subsidized interest rate of seven per cent. To make it happen, the Union Government offers banks interest subvention currently at 1.5 per cent per annum. This comes at a huge cost to the exchequer. For three year period, 2022-23 to 2024-25, it has made a budget provision of around Rs 35,000 crore towards interest subvention. Apart from the above, farmers get what is termed a prompt payment incentive (PPI) of three per cent in case they make timely payments. The banks have to bear this cost as the same is not reimbursed by the government. The PSL scheme is riddled with multiple problems.
First, the very idea of state intervention in the allocation of credit instead of letting the process be demand-driven is flawed. Such imposition from the outside in a top-down approach is bound to lead to serious distortions involving deficient availability of lendable resources in areas where these are required and surplus in others where these may not be required. Second, this has led to flagrant misuse. According to a study by the RBI’s internal working group, in several States, the quantum of crop loans was found to be higher than the value of all agricultural inputs (in Andhra Pradesh, during 2015-2017, this was 7.5 times). Considering that crop loans are taken mostly for buying agricultural inputs when the value of the former exceeds the latter, it points towards the diversion of funds to non-farm uses. This apart, most of the credit flowing to agriculture is cornered by large farmers viz. those with land holding size over 10 hectares. In sheer numbers, they are a minuscule 0.6 per cent of the total. Yet, they got away with 41 per cent of the agri-credit (2016-17). The bulk of the remaining 59 per cent went to farmers having to hold in the 2 - 10 hectares range (they are 13.2 per cent of all farmers). Small and marginal farmers (they are 86.2 per cent) got very little; in fact, nearly 41 per cent of them didn’t even have access to banks.
The irony is that farmers other than small/marginal farmers, having borrowed from banks at low rates, further lend this money to the latter at a much higher rate, thereby making a huge profit on arbitrage. This is a case of better-off farmers and even non-farmers profiteering from the State's largesse.
Third, having reserved 40 per cent of lendable resources for PSL, the availability of funds for lending to other sectors gets constrained. This results in higher pricing of loans to the latter. The cost to other sectors increases further as the banks charge higher interest rates from them to cross-subsidize the concessional rate charged on PSL loans to maintain their viability. Fourth, setting targets, sub-targets and so on gives enormous discretion to the bureaucrats in seeking compliance from banks as well as discretion to officialsFinally, the banks struggle to achieve the 40 per cent target for PSL. This has led them to petition RBI for expanding the PSL umbrella to include sectors to which they are already lending or intend to lend and the latter readily concedes. The result is: what started as a special dispensation for neglected sectors, the list has now become unwieldy.
Thus, we have export, renewable energy and now even start-ups included in PSL. ‘Sustainable finance’ could be the latest addition if the RBI accedes to the request of banks, especially foreign banks. The key point to note here is that already the latter is into such financing and its inclusion under PSL would help them comply with the 40 per cent threshold without having to make any extra effort.
To conclude, PSL is a legacy of the socialist era. It creates distortion in credit flows, keeps bank officials busy with target fulfilment and compliances and is prone to blatant misuse. It needs to go. Banks should enjoy the freedom to lend. For farmers or MSMEs who need help, the Government may credit interest subsidies directly to their bank accounts.
(The writer is Policy Analyst)
