RE-PRIORITIZING PRIORITY SECTOR LENDING FOR INCLUSIVE GROWTH AGENDA FOR INDIA

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1 RE-PRIORITIZING PRIORITY SECTOR LENDING FOR INCLUSIVE GROWTH AGENDA FOR INDIA Dr. M. M. Gandhi 1 ABSTRACT This paper critically analyses the recent initiatives of Reserve Bank of India (RBI) in Re-Prioritizing Priority Sector Lending for Inclusive Growth Agenda for India, came in to vogue w.e.f. April This paper critically evaluates and compares the recent initiatives with the previously adopted targets and methods by all the banks at the behest of the RBI. This paper argues that the Priority Sector Lending is an important role given by the Government of India to the RBI to direct the Scheduled Public Sector banks, private sector banks as also foreign banks, to adopt new targets envisaged in the new dictates, from April This paper further critically evaluates the initiatives taken by the Banks in accelerating inclusive growth based on the objective data derived from the RBI S reports and other empirical studies. This paper argues that the Priority Sector Lending is an important role given by the RBI to the banks for providing a specified portion of the bank lending to few specific sectors like agriculture or small-scale industries. This paper stresses the need of matured, positive attitude and approach and sound strategy to achieve complete the targets and sub-targets laid down under the scheme of Priority sector Lending. KEYWORDS RBI, Priority Sector Lending, Inclusive Growth, RBI Monetary Policy Review, RBI Priority Sector Lending Guidelines, Growth Projection, Social Policies, Economic Policies etc. INTRODUCTION Priority sector lending is providing easy, adequate and timely credit to priority sectors that otherwise would not receive easy finance, (Roshni Agarwal, 2013). The scope of priority sectors is confined to sectors that affect huge population segment, weaker sections in the society and sectors that are labour-intensive. Consequently, the sectors covered within the ambit of priority sectors include agriculture, education, export credit, housing, micro and small enterprises (MSME) among others. Under the priority sector lending initiative, banks generally disburse loans of small value to various sectors to aid the development of overall Indian economy. Priority sector refers to those sectors of the economy, which may not get timely and adequate credit in the absence of this special dispensation. Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, poor people for housing, students for education and other low-income groups and weaker sections. In India, growth with equity has been the central objective right from the inception of the planning process. There are a large number of people, potential entrepreneurs, small enterprises and others, who may not have adequate access to the financial sector, which could lead to their marginalization and denial of opportunity to grow and prosper. In a fast growing economy, an important issue is how to sustain and diversify growth so that the risk to growth process is diversified across sectors. Therefore, directed priority sector lending, today, has become the national objective and major concern for the economic policy decision makers. The Reserve Bank of India (RBI) s dictate obligated the Banks to adopt the national policy of directed priority sector lending for inclusive growth. The objective data derived from the RBI S reports and other empirical studies unequivocally pinpoint that the main reasons of lack of opportunities and access to finance, financial illiteracy, besides poor performance, apathy and negative approaches of the Banks. Bringing the larger population within the structured and organized financial system has explicitly been on the agenda of the RBI. Against the above backdrop, this paper, drawing upon the theoretical developments, county experiences and empirical findings, seeks to examine key issues in inclusive growth of India details the policy initiatives undertaken by the RBI therefore. In India, growth with equity has been the central objective right from the inception of the planning process. The Eleventh and Twelfth Five Year Plans, therefore, re-emphasized the need for a more inclusive growth in order to ensure that the per capita income growth is more broad-based. The RBI has very recently revised the guidelines for Priority sector Lending, w.e.f. 23 rd April The diversification of a large fraction of bank credit from the traditional sector to the priority sector is a remarkable feature of credit deployment in the post nationalization era. The concept of priority sector lending (PSL) is mainly intended to ensure that assistance from the banking system in an increasing manner to those sectors of the economy, which has not received adequate support of institutional finance. The Reserve Bank of India (RBI) emphasized that the priority sector comprised of agriculture 1 Principal, Professor and Head P.G. Department of Commerce and Management, Jaysingpur College of Arts, Commerce, Science and Computer Science (UG & PG), Maharashtra, India, dr.manojkumargandhi@gmail.com 1620 P a g e

2 (direct and indirect finance), small scale industries (SSI), small road and water transport operators, small business, professional and self-employed persons, education, housing, micro-credit, weaker sections, etc. RBI monitors the PSL by commercial banks through periodical return received from the banks and the performance of banks is reviewed in various foray set up under the lead bank scheme (RBI, 2009). Since seventies, RBI and government of India have stipulated some guidelines viz, financing in the priority sector on an increasing scale, more deployment of credit backward regions, preparation and implementation of credit plan and measures for enhancing productivity, employment and economic growth with social justice (Narasimham, 1994). The banks, without insisting adequate security, have supplied advances to priority and other neglected sections of the society at a concession rate of interest. However, the banking statistics revealed that, this designated priority sector as well as neglected sections received about 15 per cent of the total bank credit at the time of bank nationalization (GoI, 1991). On the later period, proportion of advances to the priority sector has increased from 15 per cent to 33.3 per cent in 1974 and further to 40 per cent in The commercial banks have achieved the target and even surpassed it in quantitative terms. However, in qualitative terms, there is an apprehension among the bankers that the advances to priority sector resulted in a loss of interest income due to highly subsidized lending rates. As a result, the profitability of banks has adversely affected besides maintaining additional manpower requirements for supervision of small loans, mounting over dues, poor recovery of advances and raising volume of nonperforming assets (NPAs) (Niranjana and Anbumani, 2002). The Narasimham Committee (1991) on financial sector reform has drawn attention to the problem of low and declining profitability and stated that there is need for gradual phasing out of the directed credit programme, i.e. the stipulations that 40 per cent of all credit should go to the priority sector should be scrapped. The priority sector should be redefined and the proportion shall be fixed at 10 per cent of the aggregate credit. Subsequently, the committee (1998) indicated that timely and adequate availability of credit rather than its costs is very indispensable for intended beneficiaries. The impact of Narasimham committee recommendations with regard to lending to priority sector has not been encouraging (Majumdar, 2001). It appears that there is a growing anxiety that the process of financial sector reforms has by-passed the priority sector. In this respect, Dr. Y. V. Reddy (February 3, 2001), Deputy Governor of RBI, remarked that the flow of credit to priority sector/ rural areas has not been up to the mark owing to accumulation of losses in public sector banks (PSBs) on account of mounting NPAs. The internal working group was set up by RBI under the chair of C.S. Murthy to examine the need of continuance of PSL prescriptions. On the basis of the recommendations of the working group, the guideline for PSL were revised on April 30, 2007 and overall target was fixed at 40 per cent of net bank credit (NBC) for domestic banks (PSBs and private banks) and 32 per cent for foreign banks. The target for agricultural advances fixed at 18 per cent for domestic banks and the target in case of SSI was fixed at 12 per cent for foreign banks (RBI, 2009). The PSBs are not able to reach the prescribed target of lending to priority sector. The small entrepreneurs and farmers are continued to be both credit and demand constraints. It has been reported that the constraints facing by the bankers with regard to deployment of credit to priority sector are lack of viable credit products, implying lack of demand for credit etc., (Shete, 2002). On the other hand, there exists an informal sector, which provides credit to priority sector particularly agricultural credit at higher rates of interest, which indicates that there are no demand constraints. Thus, it can be observed that the demand for funds for priority sector viz., small entrepreneurs and agricultural sector is enormous. The present paper is an attempt to diagnose empirically the various lacunas of priority sector advances by commercial banks in the area under consideration in the context of national scenario. INITIATIVES FOR INCLUSIVE GROWTH IN INDIA In order to expand the credit and financial services to the wider sections of the population, a wide network of financial institutions has been established over the years. The organized financial system comprising commercial banks, regional rural banks (RRBs), urban cooperative banks (UCBs), primary agricultural credit societies (PACS) and post offices caters to the needs of financial services of the people. Besides, MFLs, self-help groups (SHGs) also meet the financial service requirements of the poorer segments. Furthermore, development of the institutional framework in recent years has focused on new models of expanding financial services involving credit dispensation using multiple channels such as civil society organizations (CSOs), nongovernment organizations (NGOs), post offices, farmers' clubs, and panchayats as business facilitators /correspondents. Specific financial instruments/products were also developed in order to promote financial inclusion. ENHANCING EFFECTIVENESS OF DIRECTED PRIORITY SECTOR LENDING Going forward, country s vision is of universal financial access through affirmative financial inclusion, which, (Nair, 2012) will mainstream the marginalized by ensuring Access. Until we achieve the desired level of financial deepening at all levels of society, in rural as well as urban area, the need for directed lending will continue as a necessary lynchpin of the macro policy framework. Transformation of the Indian economy (Nair, 2012) has been substantial in the last two decades. Size of economy, measured by Gross Domestic Product (GDP), has increased more than three times since 1991 (at constant prices). However, share of agriculture in GDP has moderated from 31.4 per cent in to 14.5 per cent in This moderation has been an 1621 P a g e

3 outcome of accelerated growth in services and industry sectors. Agriculture sector remains important and, therefore, Approach Paper to the 12th Five-Year Plan targets a GDP growth rate of 9 per cent with agriculture sector growing at 4 per cent per annum. Agricultural sector suffers from several challenges. Hence, priority sector classification of agriculture needs to be re-examined in light of challenges faced, emerging trends, and requirements of the changing economy. In 1991, the Committee on Financial Sector Reforms (Chairman: Shri M Narasimham) recommended for phasing out directed lending and suggested focus on small and marginal farmer, tiny sector of industry, small business and transport operators, village and cottage industries, rural artisans and other weaker sections by directing 10 per cent of bank credit towards these segments. Commercial banks have been prescribed targets since late 1960s for priority sector lending. The outcome has been quite encouraging so far; however, there is need for a relook in current context. The need for directed lending in India would continue considering that, there is lack of access to credit for a vast segment of the society. The origin of directed lending is rooted in the Credit Policy for , wherein it was emphasized that commercial banks should increase their involvement in financing of priority sectors, viz., agriculture, exports and small-scale industries, as a matter of urgency. Description of priority sector was formalized in 1972 based on the report submitted by the Informal Study Group on Statistics relating to advances to priority sector constituted by the Reserve Bank of India (RBI). For the first time in 1980, the RBI Working Group suggested that scope of mandated priority sector lending be extended to private sector banks and at least 40 per cent of priority sector advances be towards agriculture. The subsequent Committees and working groups continued with recommendation of specific priority sector mandate for banks, though there have been changes in scope of priority sector definition from time to time. Commercial banks need to play significantly enlarged role for developing and deepening financial services in the rural areas and urban markets. Credit remains a scarce commodity sections/sectors and they continue to remain outside purview of the formal financial system. Therefore, those sectors where sufficient credit does not flow, those people who do not get adequate credit may get the benefit of directed lending. In view of the above-mentioned top priorities, the Nair Committee# recommendations (2012), directing future inclusive growth agenda vis-à-vis enhancing effectiveness of directed priority sector lending have vital significance. [# The Committee was constituted by the RBI on August 25, 2011 under the Chairmanship of Shri M V Nair (Chairman & MD of Union Bank), pursuant to the announcement by the Governor in Monetary Policy Statement , (vide para 94), to re-examine the existing classification and suggest revised guidelines with regard to priority sector lending and related issues, submitted on February 21, 2012 to the RBI]. Directed credit through the priority sector dispensation (Nair Committee, 2012) is a major public policy intervention for ensuring that (a) vulnerable sections of society get access to credit at an affordable rate, and (b) there is adequate flow of resources to those segments of the economy, which have a higher employment potential and help in making a large impact in poverty alleviation. Priority sector lending also supports pursuit of many objectives envisaged in the Five-Year Plans. Accordingly, there have been changes in scope and extent of coverage of beneficiaries under priority sector. Over the years, success of priority sector lending in the country is noteworthy. This is reflected in improved reach of the banking system, higher credit flow to identified segments and more importantly, increased coverage of vulnerable sections. Following mandated lending prescriptions, commercial banks have achieved success in making credit available at an affordable cost to diverse segments of beneficiaries. The Nair Committee (2012) suggests:-(a) sharper focus needs to be given in directing flow of credit to economically weaker and vulnerable sections of the society in order to achieve the policy objective of inclusive and equitable growth; (b) directed lending is an institutional mechanism for allocating credit to sectors that have high potential for generating employment and improving livelihood. The recommendations of the Nair Committee (2012) are expected to have significant impact in channelizing directing lending to those who have lack of access to credit and to those sectors, which generate large employment. It is hoped that these recommendations would promote country s developmental and inclusive goals. The Nair Committee identified key issues facing diverse segments and sections of the society; examined them thoroughly in order to make recommendations, which, on implementations, may lead to achieving the objective of directed lending. In view of the above, target of domestic Scheduled Commercial Banks (SCBs) for lending to priority sector is retained at 40 per cent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher. In view of the limited scope of the present paper, only relevant priority sectors have been categorized as per the suitability of the main theme of this present paper and analyzed accordingly herein as under P a g e

4 REPRIORITIZING THE PRIORITY SECTOR LENDING FOR INCLUSIVE GROWTH IN INDIA: RECENT INDIAN INITIATIVES The Reserve Bank of India, at the behest of Government of India, has very recently revised the priority sector lending guidelines and categories thereunder, w.e.f. 23 rd April 2015, based on the recommendations of an Internal Working Group (IWG), set up in July 2014 to revisit the existing priority sector lending guidelines. The report of the IWG was placed in the public domain inviting comments. The recommendations of the IWG were examined in the light of the comments / suggestions received from Government of India, banks, and other stakeholders and revised guidelines have been issued in supersession of guidelines issued earlier in July 2014 on Priority Sector Lending Targets and Classification. The salient features of the guidelines are as under: Categories of the priority sector: Medium Enterprises, Social Infrastructure and Renewable Energy will form part of priority sector, in addition to the existing categories. Agriculture: The distinction between direct and indirect agriculture is dispensed with. Small and Marginal Farmers: A target of 8 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, has been prescribed for Small and Marginal Farmers within agriculture, to be achieved in a phased manner i.e., 7 percent by March 2016 and 8 percent by March Micro Enterprises: A target of 7.5 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, has been prescribed for Micro Enterprises, to be achieved in a phased manner i.e. 7 percent by March 2016 and 7.5 percent by March There is no change in the target of 10 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, for Weaker Sections. Target for Foreign Banks: Foreign Banks with 20 branches and above already have priority sector targets and subtargets for Agriculture and Weaker Sections, which are to be achieved by March 31, 2018 as per the action plans submitted by them and approved by RBI. The sub-targets for Small, Marginal Farmers, and Micro Enterprises would be made applicable post 2018 after a review in Foreign banks with less than 20 branches will move to Total Priority Sector Target of 40 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, on par with other banks by , and the sub-targets for these banks, if to be made applicable post 2020, would be decided in due course. Bank loans to food and agro processing units will form part of Agriculture. Export credit: Export credit Upto 32 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher, will be eligible as part of priority sector for foreign banks with less than 20 branches. For other banks, the incremental export credit over corresponding date of the preceding year will be reckoned up to 2 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher. The loan limits for housing loans and MFI loans qualifying under priority sector have been revised. The priority sector non-achievement will be assessed on quarterly average basis at the end of the respective year from onwards, instead of annual basis as at present. The revised guidelines are operational with effect from 23 rd April The priority sector loans sanctioned under the guidelines issued prior to this date will continue to be classified under priority sector until repayment/ maturity/ renewal. Different Categories under Priority Sector w.e.f. 23 rd April 2015 are: Agriculture, Micro, Small and Medium Enterprises, Export Credit, Education, Housing, Social Infrastructure, Renewable Energy, Others. The details of eligible activities under the above categories are specified in Para III. TARGETS /SUB-TARGETS FOR PRIORITY SECTOR (i) The targets and sub-targets set under priority sector lending for all scheduled commercial banks operating in India are furnished below in Table P a g e

5 Table-1: Targets and Sub-Targets set out under Priority Sector Lending for all scheduled commercial banks operating in India w.e.f. 23 rd April, 2015 Categories Total Priority Sector Agriculture Micro Enterprises Advances to Weaker sections Domestic Scheduled Commercial Banks and Foreign Banks with 20 branches and above 40 per cent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent amount of Off-Balance Sheet Exposure, whichever is higher. Foreign banks with 20 branches and above have to achieve the Total Priority Sector Target within a maximum period of five years starting from April 1, 2013 and ending March 31, 2018 as per the action plans submitted by them and approved by RBI. 18 percent of ANBC or Credit Equivalent Amount of Off- Balance Sheet Exposure, whichever is higher. Within the 18 percent target for agriculture, a target of 8 percent of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher is prescribed for Small and Marginal Farmers, to be achieved in a phased manner i.e., 7 per cent by March 2016 and 8 per cent by March Foreign banks with 20 branches and above have to achieve the Agriculture Target within a maximum period of five years starting from April 1, 2013 and ending on March 31, 2018 as per the action plans submitted by them and approved by RBI. The sub-target for Small and Marginal farmers would be made applicable post 2018 after a review in percent of ANBC or Credit Equivalent Amount of Off- Balance Sheet Exposure, whichever is higher to be achieved in a phased manner i.e. 7 per cent by March 2016 and 7.5 per cent by March The sub-target for Micro Enterprises for foreign banks with 20 branches and above would be made applicable post 2018 after a review in percent of ANBC or Credit Equivalent Amount of Off- Balance Sheet Exposure, whichever is higher. Foreign banks with 20 branches and above have to achieve the Weaker Sections Target within a maximum period of five years starting from April 1, 2013 and ending on March 31, 2018 as per the action plans submitted by them and approved by RBI. Sources: Authors Compilation Foreign banks with less than 20 branches 40 per cent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent amount of Off-Balance Sheet Exposure, whichever is higher, to be achieved I a phased manner by 2020 as indicated in sub para. Not Applicable Not Applicable Not Applicable The Total Priority Sector target of 40 percent for foreign banks with less than 20 branches has to be achieved in a phased manner as given in Table-2 Table-2: Total Priority Sector target of 40 percent for foreign banks with less than 20 branches has to be achieved in a phased manner w.e.f. 23rd April, 2015 Financial Year The Total Priority Sector as percentage of ANBC or Credit Equivalent Amount of Off- Balance Sheet Exposure, whichever is higher Sources: Authors Compilation The additional priority sector lending target of 2 percent of ANBC each year from to has to be achieved by lending to sectors other than exports. The sub targets for these banks, if to be made applicable post 2020, would be decided in due course P a g e

6 (ii) The computation of priority sector targets/sub-targets achievement will be based on the ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposures, whichever is higher, as on the corresponding date of the preceding year. For the purpose of priority sector lending, ANBC denotes the outstanding Bank Credit in India [As prescribed in item No. VI of Form A under Section 42 (2) of the RBI Act, 1934] minus bills rediscounted with RBI and other approved Financial Institutions plus permitted non SLR bonds/debentures under Held to Maturity (HTM) category plus other investments eligible to be treated as part of priority sector lending (e.g. investments in securitized assets). The outstanding deposits under RIDF and other funds with NABARD, NHB and SIDBI in lieu of non-achievement of priority sector lending targets/sub-targets will form part of ANBC. SUMMING UP The issues facing the banking industry in attaining the goal of sustainable banking excellence inter alia include emphasis on attaining sustainable excellence through customers, employees and technology and focus on bank finance to vulnerable sections of the population, which have, hitherto, been largely neglected and hence, require special emphasis in order to attain the goal of sustainable banking excellence. The interplay of the three elements of customers, employees and technology would be keys to attain the goal of sustainable banking excellence, (Chakrabarty, 2013). The concept of enhancing the productivity in Indian Banking is widely accepted, which perform the important function of financial intermediation in the economic system. High productivity in performing this function requires banks to have operational and allocation efficiency. Operational efficiency entails performing the intermediation function at the lowest cost. Allocation efficiency requires that resources are allotted to the most deserving and productive segments of the population. The entire scheme of priority sector lending in India is aimed at attaining greater allocation efficiency, thereby facilitating effective financial intermediation by banks. An effective and transparent framework for priority sector lending, which is the objective of our revised priority sector guidelines, would help attain improved productivity/ efficiency and ultimately, the goal of sustainable excellence in banking. REFERENCES 1. (2010, April). The AFI Survey on Financial Inclusion Policy in Developing Countries, Preliminary Findings. AFI. Retrieved from 2. Ahmed, J. U. (2005). Bank Financing of Small Scale Industries: A Diagnostic Evaluation. Ahmed (ed.), Industrialization in North Eastern Region. New Delhi: Mittal Publications. 3. Ajit, D. (1997, October 18). Para Banking in India, Some Issue. Economic and Political Weekly, XXXII (42). 4. Angadi, V. B. (1983, March 26). Bank s Advances to Priority Sectors: An Enquiry in to the Causes of Concentration. Economic & Political Weekly, XVIII (13), Bhati, S. (2006, December). Trust between Branch Managers and Loan Officers of Indian Banks. International Review of Business Research Papers, 2(4), Chawala, A. S. (1979). Nationalization and Growth of Indian Banking. New Delhi: Deep and Deep Publication. 7. Chakrabarty, K. C. (2012, September 04). Revised Guidelines on Priority Sector Lending: Rationale and Logic, Special Address by Dr. K. C. Chakrabarty, Deputy Governor, Reserve Bank of India at the FIBAC 2012 organized by FICCI and the Indian Banks Association at Mumbai. 8. CGAP. (2012). Commentary on the Rangarajan Committee Report (2008) on the Blog of CAGP-MICROFINANCE- GATEWAY. Retrieved from 9. Deccan, Herald. (2012, July 21). Priority Sector Lending for Foreign Banks raised to 40%, a news-item published in the supplement. Business, of the daily newspaper Deccan Herald, pp. 3, Mumbai, PTI. 10. Ghosh, A. (1982). Role of Banks in Implementation of New 20-Point Program (Report of the Working Group). 11. GPFI. (2010). Global Partnership Financial Inclusion (Report of the Committee). Retrieved from Bodies%20and%20FI.pdf 12. (1991, December). Financial System (Report of the Committee). Government of India. Ministry of Finance. 13. (1998, April). Financial System (Report of the Committee). Government of India, (Narasimham Committee-II). Ministry of Finance P a g e

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