S S Mundra: Priority sector lending - status, issues and future
agenda
Inaugural address by Mr S S Mundra, Deputy Governor of the Reserve Bank of India, at the
"Conference on Credit flow to Priority Sector - Policy and Implementation", College of Agricultural
Banking, Reserve Bank of India, Pune, 27 June 2017.
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1. Colleagues from College of Agricultural Banking (CAB); In-charges of Priority Sector Lending
in various banks assembled here and my colleagues from various regional offices of RBI who
have joined over video Conference- A very Good Morning to all of you! I consider hosting of this
Conference on Credit Flow to priority sector by the CAB, a very timely initiative indeed. Such
conferences are extremely important as they provide a platform for exchange of views and
feedback that serves as inputs for policy formulation. I believe that policies framed in isolation will
look good on paper but would not serve much purpose when implemented on ground.
Introduction
2. The overarching philosophy behind prescribing the priority sector target for banks is to enable
sections of society, which though credit worthy, are unable to receive credit from the formal
system, either in adequate measure or in a timely manner. There are economic reasons why
some sectors/borrowers do not receive adequate finance. At any given point of time, the lendable
resources at institutions are limited and there is always a trade-off between how much time and
effort can be put in and what kind of topline and bottom line the new businesses would generate.
Given this sort of business dynamics, it is possible that the sectors which rightly deserve bank
credit get excluded. This is precisely the motivation behind institution of priority sector lending
norms. These guidelines are revised from time to time keeping in view the developments in the
economy.
Priority Sector Lending (PSL): A Business Case
3. Before I come to specifics, let me touch upon certain policy and strategy issues. The PSL
Guidelines have been in existence for a long time now- there are targets, sub targets, but sadly
most of the time, these norms are viewed more as a matter of compliance. The first and the
most important message which I would like the PSL chiefs of the banks present here to carry to
your senior management and the Board of Directors is that lending to priority sector is good
business for all the right and justifiable reasons. Perhaps, it would be possible for you to put
across your arguments more persuasively now than ever before. I say so because in the last few
years we have seen over exposure of banking system to large corporates and consequences
thereof. The excessive lending to corporate sector was the outcome of what I call "least input
and maximum output" approach. With little effort one could create large credit volumes whereas
creating similar volumes in the priority sector would have required commitment of larger
resources in terms of branch staff and operating people.
4. There is another dimension to why focusing on smaller loans would become all the more
necessary now and that is the regulatory aspect. Couple of noteworthy changes have happened
in the recent past (i) there is a revision of single and group borrower exposure limit (ii) an overall
ceiling on exposure of an entity to the banking system has been mandated. These developments
would push the corporates to gradually shift to markets for meeting their funding requirements.
Apart from bitter experience of the past and need for risk diversification, earning potential
presented by priority sector lending is another reason why banks should look elsewhere for better
business opportunities. Having said that, we have already been witnessing a conscious move by
the banks into 'retail' segment from corporate. I am not suggesting that movement to retail is not
okay, but from overall economic and credit perspective, retail loans are not productive loans in
the hands of the borrower as they neither generate income nor they lead to further economic
activities. On the contrary, loans to segments such as agriculture, small and micro enterprises
do support economic activities, generate income and also surplus. Such borrowers then become
worthy recipients of retail credit. That is the larger philosophy and reason for moving over to
priority sector as a business case.
Is there a true priority sector vertical?
5. The second thing which I want to mention, something which is more relevant for public sector
banks, to some extent for RRBs and possibly for some private sector banks as well, is about the
way the priority sector vertical works. Typically in a public sector bank, the responsibility for
priority sector is spread across several verticals. There is a rural credit or an agricultural finance
vertical, a separate MSME vertical, the affordable housing segment may be part of retail and the
renewable energy & the medium industries, included in the priority sector in the last revision,
quite possibly, may be with mid-corporate or large credit or corporate group. There may even be
another financial inclusion vertical sitting still separately. I am not sure whether there is any
coordinated effort between these verticals to chalk out a comprehensive strategy for lending to
priority sector. Resultantly, the priority sector vertical is reduced to a data collection and
statement generating vertical. Further, I am also not sure how many Bank Boards discuss
priority sector strategy in the board meetings.
6. It is necessary that all these verticals evolve within themselves and come together as a
cohesive group, prepare a strategy and then take it to the Board for broader discussion and
guidance. The priority sector activity should not remain confined to being a mere data collection
exercise.
Is there a linkage between plan approved by SLBC and plan of the priority sector
vertical?
7. There are several agencies involved with priority sector activities of banks. There is the SLBC
structure wherein District Credit Plan (DCP) is prepared and the Lead Bank offices operate at
district level. NABARD prepares the Potential Linked Credit Plan (PLP), SLBC adopts it and then
it is distributed amongst all banks. I have a suspicion that between the overall priority sector
strategy and what happens at the SLBC and DCP level, there may not necessarily be any logical
linkage. In RBI we are looking at revamping the entire structure of SLBC and as such, some of
these will undergo a change.
Data extraction and its implications for priority sector
8. Currently we have a project underway within RBI which would enable extraction of data directly
from banks' Core Banking Systems (CBS). In the entire credit planning exercise data infirmity
has been a major factor and in some sense, has become an impediment for banks in arriving at
right conclusion and right strategies. This project is at a fairly advanced stage now. However
once this is implemented, it should not once again be seen as a data cleaning and compliance
exercise. This is a great opportunity for banks because they can use the data, apply analytics
and prepare the right sort of strategy. They can decide on their focus area and product once this
robust set of data is available. It is important that the senior-level functionaries appreciate this
exercise in that sense.
Research
9. The last point that I would like to make on the broader policy and strategy aspect is that time
has come for individual banks to also invest in research- not very intense academic
researchbut research to the extent that is helpful in making policies and business strategies relevant for
their own purpose.
10. Let me now come to some recent changes and emerging opportunities in the priority sector.
Diversified universe
11. In the last revision the scope of priority sector has been enhanced substantially. Some new
sectors like renewable energy, medium enterprises, agro processing, social infrastructure and
agricultural infrastructure have been included. Thus, new activities have been allowed but at the
same time, to make sure that the most deprived within this large umbrella are not put to
disadvantage, certain sub-limits for small and marginal farmers and micro enterprises have also
been introduced. This kind of revision and structure gives the flexibility to each one of you to
identify your area of strength and put maximum effort there. This way you can generate surplus
and trade that in the Priority Sector Lending Certificate (PSLC) market while buying certificates in
areas where others have generated surplus. This is how the whole philosophy of PSLC will work.
I will dwell upon the developments in the PSLC market a little later.
Potential for job creation, self-employment and implications for priority sector
12. There are few emerging opportunities. One arises from the demographic changes which lead
to entry of large number of job-seeking youth within the system. It would not be realistic to expect
all of them to be absorbed only in the formal sector. Many of them would be gainfully employed in
pursuing vocations like low-level manufacturing, services or would operate small enterprises.
Thus, large number of people will have the potential of being self-employed and that by
translation would mean business for banks. There are various GoI initiatives like Make in India,
Start Up India which are aimed at providing a fillip to this eco- system. But unless there is
research, analysis of data, policy and strategy, these opportunities cannot be exploited
completely.
Rapid urbanisation and its implication for priority sector
13. The other broad phenomenon which is unraveling and would likely accelerate in the days
ahead is rapid urbanization. At present about 32% of the population lives in urban areas and it is
expected that in next ten to fifteen years, this figure will be around 42%. This phenomenon once
again brings to the fore the need for proper communication among various verticals and a
cohesive strategy for the bank a whole. For example, the people shifting from rural to urban
areas- they may be your client in rural area but when they migrate to semi-urban or urban areas,
is there any exchange of information between the rural and the semi- urban/ urban branches
about where these people are migrating? Such communication assumes significance because
when they migrate they would have new needs and they might adopt a vocation, which may need
funding; that's why I am suggesting that as a business strategy banks need to have an integrated
approach. They must create appropriate communication channels to tap such potential in the
migrating population.
Is Financial Inclusion (FI) a part of priority sector?
14. As I mentioned earlier, in many banks FI is a separate vertical. In such situation again there
would be absence of coordination. One very strong and nuanced point which you really have to
carry back from this conference and work on is that we become conditioned to working in a
certain kind of organizational set up, we continue to work in silos, a thought never comes to the
mind that there may be a need to integrate all this and it can throw up a very interesting and new
structure. I suggest that you can include the FI vertical as part of the priority sector vertical if it
exists separately within your overall strategy.
Low cost credit delivery through technology
15. Finally what you need to bear in mind is that the small and marginal farmer, micro
enterprises, affordable housing very well become half or more than half of the priority sector.
However, if this segment is to be served profitably, it can only be done with intense use of
technology and therefore, banks need to have low cost delivery model. Quite a few banks both
from public and private sector have developed technology-based low cost credit delivery models
and are doing quite well.
Use of alternative credit scoring models
16. The segment comprising of micro enterprises etc., if you try to fit them in regular credit rating/
scoring model that will not work. If you want to judge them against the usual norms of debt equity
ratio, debt service coverage ratios etc., it will be a non-starter. Therefore you have to look at the
method of credit scoring again. A lot of work in this regard has been done in our financial system
and many players have moved to credit scoring where payment history, remittance history, bill
payment history etc. are collected as data points for analyzing borrowers' repayment capabilities.
Today all these data points are available one way or the other. Some of the banks have used it
for developing pre-approved limits for small borrowers. This is done in advance and borrowers
do not need to approach the banks rather it is the banks that approach the borrowers. We have
had hunting limits for corporates and now the time has come when this has to be made available
to small borrowers and the common person.
17. These are some issues that I wished to share with you on the execution side of priority
sector. One has to be mindful of the opportunities which are emerging and take advantage of
these opportunities to make priority sector lending successful.
Performance under priority sector lending
18. Now I will quickly come to some of the issues around credit flow to priority sector. When I
look at the performance under newly introduced sub- targets for 2016-17, though the data is
provisional, I find some interesting trends. Both public sector and private sector banks have done
well under overall priority sector lending targets. Public sector as a group is slightly below 40%
mark whereas private sector banks have exceeded 40% by a good margin. Foreign banks with
more than 20 branches are adhering to their roadmap as they have to gradually reach the
milestones. Foreign banks with less than 20 branches, as of now, also appear to be on track.
19. While in the case of small and marginal farmer target, the public sector banks have slightly
exceeded the sublimit of 8%; the private sector banks have fallen short of these targets and
achieved around 5% during 2015-16. Even in 2016-17, it has not improved substantially. On the
other hand, the public sector banks could not achieve the sub-target under micro enterprise while
the private sector banks could exceed the target (more than 8%) in this segment. It quietly brings
a larger point that the priority sector activities of private sector banks still remains predominantly
urban- focused even while they have developed good rural network and if not so, alternatively the
hub and spoke model is functioning. I will leave it to the strategies of banks as to the areas
on which they want to focus; however, one has to be conscious that there may not be an
unending supply of PSLCs if there is a gross deficit coming from one particular
subsegment. Perhaps it will be a good business strategy to leave the deficit in marginal terms and
not in a larger percentage as it may later on prove to be a costly situation.
Enablers in priority sector lending
20. Now let me briefly touch upon some of the enablers which have been put for the increased
credit flow particularly to MSME sector because this is a sector which is very important and
crucial for job creation which is both a requirement and a challenge for the country.
a. MSME Sector
(i) Factoring transactions
To increase liquidity support for the MSME sector, RBI had allowed factoring transactions on
'with recourse' basis to be classified as eligible for priority sector by banks. Further, the factoring
transactions taking place through TReDS are also eligible for classification under priority sector.
It is understood that many banks have their own vendor finance platforms akin to TReDS where
they are undertaking factoring transactions on without recourse basis to MSME and with
recourse to the corporate. Since two entities licensed under TReDS have become operational, it
is expected that it will lead to better price discovery and more favorable rates for MSMEs . With
added benefit of priority sector status, banks may actively consider undertaking 'without
recourse' factoring transactions through TReDS.
(ii) Capacity Building
Over the last two years, CAB has taken a major initiative for capacity building of bankers for
lending to MSMEs, popularly known as NAMCABS. I understand till now more than 5000 bankers
have been trained. If we reflect back, NAMCABS has put emphasis on three categories of
participants, i) policy makers at the corporate office ii) officers sitting in specialized MSME
branches and iii) the trainers in the individual bank's training establishments. However, CAB
cannot be expected to train the entire banking community. Idea was to create a focus group
within the bank which could act as the force multiplier. But if these trained resources are not
gainfully employed, then it defeats the very purpose of the capacity building efforts being made by
the College.
(iii) Cluster approach
Empirical evidence suggests that the MSME lending is much more meaningful and strong if
cluster approach is adopted. Rather than financing stray units on standalone basis, if the banks
are looking for business opportunity and furthering credit flow to units having strong repayment
potential, then cluster approach becomes very much meaningful. I would suggest that not only
should banks focus on financing in existing clusters, but also encourage promoting of such
clusters. To do so, banks need to have a strong data base support and in-house research to
identify the area, the activity and develop a delivery model.
(iv) Co-origination of loans
The next point relating to MSME and more so to micro units is something about which I have
been speaking in various fora for quite some time. This is on co-origination of loans where some
work is being done within the RBI. If one looks at the sector, which has received maximum credit
from banks, it is the financial intermediation sector. This means banks have been lending to
NBFCs/ MFIs/ housing finance companies for on-lending purposes. To my mind, this is an
example of lazy banking and no one gets benefitted at the end- neither the banker nor the
ultimate borrower. So can we develop a regular co- origination model? Banks and NBFCs/ MFIs
can join together in origination of loans in a certain agreed structure of risk sharing and various
covenants around the loan. This will provide a good avenue to banks to expand their portfolio and
diversify their risk. It will be remunerative also and at the same time will help banks' priority sector
compliance as well. This is under discussion in RBI and we will take a final view in some time.
b. Priority Sector Lending Certificate (PSLC)
The response to the PSLC trading has been encouraging. In the first year itself, about 1,26,549
crore worth of offers were put on the PSLC platform, out of which roughly 49,800 crore worth of
offers were settled, which is a good beginning. Among the four categories under PSLC trading,
higher trading is observed under PSLC-Small and Marginal Farmers and PSLC- General
Category. Among the four categories, the transaction volume is about 23,000 crore under small
and marginal farmers, 20,000 crore under general category and rest of the amount under other
two categories. As expected, most of the trading occurred especially at the end of the quarters,
since the priority sector lending targets are currently monitored quarterly. The PSLCs which were
traded in the first quarter were traded at higher premium and this is obvious because the PSL
rights get extinguished by March 31st. PSLC platform is an order matching platform but a
disquieting feature that we have observed is that some entities strike a bilateral trade and then
put it on the platform which vitiates the spirit of anonymous order matching. PSLC should be
used as it is designed and meant to be used and not merely as a reporting platform.
21. Before concluding, I would quickly mention a few things, which are relevant to all categories
of banks- public sector, private sector, regional rural banks and small finance banks.
(i) Low cost housing and sanitation
Within priority sector, low cost housing is emerging as a high potential area and banks should
focus on that. In the last revision, we have allowed lending to individual sanitation infrastructure to
qualify as priority sector. There is also a national mission for Swachh Bharat and a movement for
creation of toilets in individual household by Government of India. Within the overall priority sector
planning, banks must look to focus on providing lending for creation of sanitation infrastructure.
(ii) Agriculture value chain financing
The second area is agri-financing. Until and unless, there is an organized movement to finance
agriculture value chain, this will remain more a compliance activity and will not provide the kind of
benefit the economy should receive. Unless agri-financing is dovetailed with value chain, the
credit flow to this segment will be more of a compliance matter.
(iii) Financing water conservation and solar pumps as an economic activity
The third area is water conservation. From my personal experience from my previous stint in a
commercial bank, I can say that water conservation can be exploited as an economic activity for
bank credit in many parts of the country. In time of drought, it supports crop cultivation and in long
term, facilitates raising of ground water table. Banks should look at it critically. Again this activity
requires research, survey and building -up a model to reach out to farmers. Similarly solar
pumpsets could be another area for bank finance. All these efforts will be very much meaningful for
small and marginal holdings. These are the kind of things, which can prove meaningful but this
will be an incomplete exercise without simultaneously providing support to financial literacy.
(iv) SHG bank linkage model
Another area is SHG model. SHG model has been a robust model in the past. There has
however, been some slowdown of late; but banks should also look critically into the credit
delivery through SHG bank linkage model.
(v) Rural posting
Specifically in public sector banks, there is a need to critically look at the entire policy of rural
posting. There are rules and other regulatory requirements, but within that framework banks need
to have a more meaningful policy for rural posting. Bank staff posted in rural areas should remain
there for a reasonable period and second, whatever period they are there, they should deliver to
an optimum extent. I know this is a major issue in the functioning of rural branches of banks and
as in-charges, you need to look into this area closely.
(vi) Small Finance Banks (SFBs)
RBI has recently come out with a detailed compendium of priority sector guidelines for SFBs.
SFBs have also been allowed to trade in PSLCs once they are operational even without waiting
for acquiring 'scheduled' status. More than 15% of trade happening under PSLC is by SFBs,
which is a healthy trend. From the current year itself, the SFBs have been allowed to participate
in SLBC meetings but there is no requirement for them in the annual credit plan until April 2018.
For SFBs, payment banks as their BCs could emerge as a good combination as many payment
banks have wide last-mile reach.
Conclusion
22. I would like to conclude here just by mentioning that all of you as in-charges of priority sector
lending in your respective banks can make a difference in a large constituency, which is priority
sector. Each credit extended by banks to priority sector can be a life changing event and the
priority sector credit as a whole can change the lives of a multitude of people of this country. You
have to consider your role as that of a change agent. I urge all of you to schedule a discussion
with your Top Management, convey to them the take- away from this conference and then take it
to your Board.
I wish you all the best and thank CAB for inviting me to address this gathering.