Banking on reforms: RBI’s new norms can help promote efficient lending practices

With the new guidelines in place, industry experts say that this flexibility being provided by the central bank will not only allow banks to efficiently utilise their resources in their strong business domains, but will also go on to help develop a secondary market for trading and provide liquidity for such papers.

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Currently, while all domestic and foreign banks with at least 20 branches are required to lend a minimum of 40 per cent of the Adjusted Net Bank Credit or credit equivalent amount of off-balance sheet exposure (whichever is higher) to the priority sector (agriculture, micro credits, education and social housing, and promote financial inclusion, particularly in rural areas), they are also required 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. Though the target and the sub-targets have been retained, the RBI has now permitted banks to buy PSLCs issued from banks that have overachieved their targets and thereby meet the regulatory requirement.

How it will work

This will work on the lines of carbon credit trading where a renewable energy company or plant accumulates carbon credit and then sells it to another company, thereby, giving them the right to emit one tonne of carbon dioxide.

According to the RBI, PSLCs will allow market mechanism to drive priority sector lending by leveraging the comparative strength of different banks. It said that while a bank with expertise in lending to small farmers can over-perform and get benefit by selling its over performance through PSLCs, another bank— better at lending to small industry—can buy these certificates while selling PSLCs for micro enterprise loans.

As per an illustration put out by the RBI: Bank A may sell PSLCs with a nominal value of Rs 100 crore to Bank B on July 15, 2016. Bank B will reckon Rs 100 crore towards its priority sector achievement as on the reporting dates of September 30, 2016, December 31, 2016 & March 31, 2017. Bank A will subtract the same from its achievement figures for the respective reporting dates. The PSLC will expire by March 31, 2017.

While banks can buy PSLC for overall priority sector target by paying a fee, they can also buy it for achieving sub-targets like agriculture, micro-enterprises and weaker sections.

Experts say that it is not easy for all banks to meet the target and it was desirable that some flexibility was provided to banks. “It is an interesting innovation and is in line with other changes that the RBI has brought for priority sector lending. Directed credit on a large percentage of credit book is not desirable and some degree of flexibility was required. Also, many foreign and small banks don’t find it viable to do rural banking or lending to SMEs, so this will help them meet their targets without deploying much of their resources for the same,” said Abheek Barua, chief economist at HDFC Bank.

Along with PSLCs, RBI has also widened the definition for the category. Speaking at an event last week, RBI Deputy Governor SS Mundra said that while target for banks’ lending to micro enterprises has been progressively increased to 7 per cent by March 2016 and 7.5 percent by March 2017, medium enterprises have been brought within the ambit of priority sector, whereby all loans to medium enterprises in the manufacturing sector and those up to Rs 10 crore in the service sector now qualify for priority sector classification.

There are others who feel that since 40 per cent is a big number and the ticket size of such loans is small, banks are required to divert a large part of their resources in meeting the PSL target and therefore it is not feasible for many banks.

“In the new banking ecosystem, there are different kinds of players who are focussed on different aspects of banking. If some small banks are doing priority sector lending, then by allowing them the issue and sell certificates, you are providing them with the liquidity and also creating a business model for them,” said Brinda Jagirdar, former chief economist at SBI. Adding that it is a great initiative by the central bank, Jagirdar further said, “Many banks found it tough to reach out to small borrowers as the ticket size is small and the customers are scattered and a huge effort was required from banks to meet the target. While this will allow universal banks to focus on other businesses and thereby increase the efficiency and productivity of their employees, it will bring synergy between large and small banks that are doing the priority sector
lending.”

Banks used to scramble towards the end of the year to meet their PSL targets. Sources reveal that banks, when not in a position to meet the target, deploy money into RIDF. Another expert said that some banks would go to a few exporters at the last minute and ask them to take a loan so that they are on the right side of the guidelines.

“While many banks are not into the priority sector lending business, they would somehow look to meet the target at the end of the year. That is not objective,” said a banker who did not wish to be named.

Interestingly, RIDF offers comparatively lower yields and thus serves as a key disincentive for banks to fall below their priority sector lending targets.

A report released by the Moody’s on Monday said that the PSLC guideline is credit positive for banks that do not have expertise in making priority sector loans. “It allows them to focus on their strengths and purchase credits from banks with expertise in making such loans, instead of diverting their own resources toward meeting priority sector lending targets,” said Moody’s.

The report also pointed out that there is no transfer of assets associated with the sale of the certificates and thus the underlying credit risk and the funding requirements continue to be retained by the originating entity.

“This should make transactions in priority sector lending certificates very straightforward because there would be little due diligence required. This contrasts with the current practice, in which banks must buy out priority sector loan assets from other entities in order for them to be counted as part of their priority sector lending obligations,” said Moody’s report.