Relevance: GS-3: Indian Economy, mobilization of resources, changes in industrial policy and their effects on industrial growth.

Key Phrases: Priority Sector Loan, Macro-economy, NABARD, Priority Sector Lending Certificates, market mechanism, Demand-Supply Framework, Small/Marginal Farmers, PSL guidelines, Pradhan Mantri Jan-Dhan Yojana, Increased public investment.

Why in News?

• Trading in these certificates helps banks reach their target, but does not incentivise them to boost their priority sector lending.

Context:

• The year 1972 witnessed crystallisation of a formal definition of priority sector. Subsequently, priority sector loan (PSL) guidelines underwent major changes. The initial exuberance of banks to promote PSL ebbed gradually due to several factors including those related to macroeconomy in general and agriculture sector in particular, which impacted credit absorption capacity in rural areas.
• With rising incidence of unproductive loans and excessive external interferences, bankers’ enthusiasm to lend to the priority sector waned leading many banks to fall short of the stipulated targets — overall and sub-sectoral.
• Efforts were made to widen the scope of PSLs so that banks could lend to new segments directly besides supporting, indirectly, the asset creation efforts by such apex financial institutions as NABARD (Rural Infrastructure Development Fund - RIDF), NHB, SIDBI and MUDRA Bank.

Mechanics of the Scheme:

• The Priority Sector Lending Certificates (PSLCs) scheme, which was operationalised by the RBI in April 2016, originated from the Planning Commission’s Committee on Financial Sector Reforms (Chairman: Raghuram Rajan). The scheme is akin to the carbon credit scheme although equating the issues of environmental pollution and agricultural development in India is a moot point.
• The so-called “market mechanism” underlying the scheme is based on demand-supply framework. Banks finding PSLs unprofitable and underachieving the targets/sub-targets would demand PSLCs which would be supplied by those overachieving the targets/sub-targets and vice versa. The buy-sell would continue until both find it profitable, i.e., until equilibrium prices are reached.
• Thus, the scheme envisages ‘aggregate’ PSLs to improve with banks, which are more efficient at making PSLs, overshooting their targets/sub-targets and offloading, at the market price, their ‘excess-achievement’ to those which are less efficient at making PSLs and ‘undershoot’ their targets/sub-targets. The RBI’s core banking solution portal, e-Kuber, facilitates trading in PSLCs.
• Normally, PSLCs are issued against the underlying assets; however, in the transaction, there is no transfer of risks or loan assets from the seller to buyer.
• There are four types of PSLCs:
  • Agriculture,
  • Small/Marginal Farmers (PSLC–SF/MF)
  • Micro Enterprises and
  • General — that is, other than loans to agriculture and micro enterprises.
• A bank having shortfall in achievement of any sub-target will have to buy the specific PSLC to achieve the target. However, if a bank is having shortfall in achievement of the overall target only, as applicable to it, it may buy any of the available PSLCs.
• Under the Goods and Services Tax, PSLCs are taxable as goods at a standard rate of 18 per cent.

Progress of Priority Sector Lending Certificates

• As per the RBI data, the total trading volume of PSLCs, which was ₹498 billion at March-end 2017, increased to reach ₹5,890 billion at March-end 2021, implying increasing participation and liquidity in the market.
• Among the four PSLC categories, trading volume is observed to be the highest in respect of PSLC-General followed by PSLC–SF/MF.
• Normally, public sector banks (PSBs) and private banks are major buyers and sellers of PSLCs. However, if buying and selling are netted, private banks and foreign banks emerge as major buyers, and PSBs, RRBs and SFBs as major sellers.
• PSLCs help banks ‘reach’ the stipulated PSL targets in contrast to ‘incentivising’ them to ‘actually’ increase their PSL. Therefore, the beneficiaries are banks which default on achieving the stipulated PSL targets/sub-targets, not the priority sector as such, and to that extent, it can be said that the scheme serves its purpose.
• During 2020-21, one out of 12 PSBs fell short of its PSL target to the tune of nearly ₹100 billion, potentially depriving an estimated 0.3 million priority sector borrowers. Thus, by facilitating ‘delegation’ of target attainment, the approach to and objectives of PSL have been further diluted, besides the aforementioned dilution via contribution to the apex financial institutions.

Why Priority Sector Lending Certificates market Growing?

• The 40 per cent target stipulated by the PSL guidelines is applicable to banks, individually. Thus, the logic behind PSLCs would result in uneven deployment of PSL across geographies and, by extension, imbalanced agricultural and rural progress, since it is possible for bank/s to lend excessively or marginally under PSL.
• Sans risk-transfer, the provision to issue PSLCs up to 50 per cent of the previous year’s PSL achievement, without having the underlying in its books, makes the scheme too accommodative.
• Since PSLCs can substitute for contribution by banks to RIDF, the contribution has slackened, which does not augur well for rural infrastructure development by NABARD.
• It is time private banks deepened their rural engagement. Even in the financial inclusion movement, they are nominal players. For instance, as on March 23, 2022, private banks’ share in the Pradhan Mantri Jan-Dhan Yojana stood at 2.9 per cent, 2.9 per cent and 3.5 per cent in terms of number of beneficiaries, amount of deposits and number of RuPay cards issued respectively.
• In today’s tech-driven ecosystem, it is not necessary for private banks to set up brick-and-mortar branches in rural areas and staffing them in order to lend there. Private banks need to increase their lending to agriculture infrastructure and ancillary activities under PSL, if not to individual borrowers.

Way Forward:

• All banks need to disclose appropriately the commissions earned from PSLC trading which in turn will help evaluate the economics of the facility to individual banks.
• In sum, it is the banks, not the priority sector, which have benefitted from the PSLC scheme. However, from a macro perspective, deficiencies in PSL aren’t the only problem confronting rural development; the crying need is to improve the overall agricultural situation through a package of modern initiatives encompassing every aspect of the farm sector.
• Increased public investment will augment credit absorption capacity. Institutional realignments are equally pressing. It needs to be weighed whether today, so many banks of so many genres with so many branches and schemes are required at all. Consolidation on all fronts would improve policy-level efficacy, operational efficiency and reach of the rural credit delivery system in significant ways. And, finally, undue external interferences need to be leashed, if not eliminated.

Source: The Hindu BL

Mains Question:

Q. Discuss the role of RBI guidelines of priority sector lending as important for the development of the basic needs of the country that are to be given priority over other sectors.