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Informist, Friday, Sep 20, 2024

--RBI paper: Growth in priority sector loans aids bks' asset quality 

MUMBAI – Priority sector lending is helping improve banks' asset quality, a paper published by the Reserve Bank of India published today said. The paper debunks the myth that high growth in priority sector lending leads to a deterioration in banks' asset quality.

"Historically, loans originating from priority sectors have had higher NPAs (non-performing assets) than their non-priority sector counterparts, of which the majority have been on PSBs’ (public sector banks') books. However, the trend reversed in 2015, in part due to better recognition of NPAs after the asset quality review," the paper said. 

As per the current rules, scheduled commercial banks are required to extend at least 40% of their loans to priority sectors. Of the total target, 18% is slated for agriculture, 10% for small and marginal farmers, 7.5% for micro-enterprises, and 12% for weaker sections. If banks fail to meet these targets, they must fund government development programs for the relevant sectors.

The article attributed the rise in priority sector lending to the introduction of priority sector lending certificates. The certificates were introduced in 2016. These have aided some banks in carving out a niche in particular priority sector lending categories, the paper said.

Trading of the priority sector lending certificates is allowed for the four categories that have mandated targets under the RBI’s guidelines, namely agriculture, small and marginal farmers, micro enterprises, and the general category.

According to data, banks lend more to their specialised sector than the required limit and turn these excess advances into certificates, which they then sell for a premium. This has helped the banks to improve their overall priority sector lending share. 

As per the analysis in the paper, the asset quality of the priority sector portfolio plays a significant role in determining the priority sector lending share of banks. Although priority sector lending is mandated by regulatory requirements, banks take into consideration the usual risk-return trade-off when extending these loans, the paper said.

According to the findings, banks with larger branch networks in urban areas offer a higher percentage of loans to priority micro-enterprises. However, loans extended for agricultural purposes are not that significant for banks with a higher rural presence. 

"Lending programmes like priority sector lending have been put in place to enhance formal credit availability to the needy sectors. Cross-country literature on directed lending remains inconclusive on the impact it has on banks’ health," the paper said. It added that such lending can be successful when supplemented by appropriate institutional mechanisms, strict performance standards and policy framework.  End

Reported by Siddhi Chauhan

Edited by Deepshikha Bhardwaj

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