Priority Sector Lending – An opportunity or a liability?
Posted in Finance Articles, Total Reads: 4435
, Published on 31 October 2013
"Today, we have an explosion in banking wherein a bank's most trusted customers are not the rich but the poor," - Chidambaram at the J&K Bank's 75th anniversary celebrations.
According to the Annual Report of RBI 2012-13, 16 out of 26 Public sector banks, 50% of private sector banks(10 out of 20) and 2 out of 41 foreign banks could not meet the targets set by RBI for priority sector lending(PSL). While this figure seems alarming, the question is why the banks have failed to achieve their targets in spite of such huge opportunities in the Indian banking sector, especially in rural areas. Is PSL a liability and a burden for the banks or an opportunity to explore the virgin market across the remotest territories?
The priority sector lending mainly refers to those sectors which do not get sufficient credit on time due to lack of ‘special dispensation’. Those who are directly affected comprises of mainly weaker sections of society like farmers and small scale industries. Some of the reasons for not getting sufficient credit can be:
Lack of Credit Worthiness of the firm to repay the debt
Lack of collateral security of the individual borrower
Lack of sufficient documents needed to be eligible to get a loan
While there is no denying the fact that in absence of sufficient proof or security, the bank has the right not to lend money, the RBI has identified certain sectors as priority sectors for easier credit. In a country where around 50% of population is in agriculture industry, 29.8% of population below national poverty level and only 35.5% Indians avail bank facility, the RBI has identified this as a vital step towards economic development of the country.
A key reason why the commercial banks have become risk averse in lending is the rising level of NPA (Non Performing Asset). Almost half of the total NPAs (47%) of public sector banks are attributed to priority sectors, reducing slightly from 52% in the year 2011. Failures to meet these targets by the banks have to be compensated by contributing towards NABARD's Rural Infrastructure Development Fund (RIDF) or funds of other financial institutions as per the specifications of RBI. This explains why the public sector banks, in spite of having extended reach in the rural areas, are still not able to meet the targets mandated by RBI.
While the commercial banks have struggled to penetrate in the untapped market in the rural areas, the Micro-finance institutions leverage on their ability of reaching out to interior parts of the country and offering credit to the people who otherwise don’t have access to it. Since their cost of capital is high, MFIs charge a higher rate of interest from the beneficiaries. In spite of this they thrive well owing to their model of ‘door-step’ delivery of credit facilities. Rate of default is also surprisingly low. However, in 2010, Andhra Pradesh came down heavily on Microfinance Institutions in India owing to the strong-arm collection tactics followed by them, which drove a lot of farmers to suicide.
MFIs follow the Joint Liability model which was pioneered by Mohammed Yunus, founder of Grameen Bank in Bangladesh. Clients form ‘groups’ of five members who share the responsibilities for loan repayment for each individual in the group. These small groups are further organized into ‘centres’ consisting of 4-8 groups each. Weekly centre meetings are held, where borrowers pay back the weekly instalments. This kind of group lending system creates peer pressure on members in the group to repay back the loan by causing social embarrassment. The system also encouraged group members to assist defaulting members in cases of genuine difficulties. Within a span of nine years (2007), Vikram Akula led SKS Microfinance grew to be India’s third largest MFI with 380,000 members and a portfolio of Rs. 175 crore. Effective interest rates charged by SKS Microfinance are higher owing to the labour intensive nature of their business model like holding face to face meetings weekly, travelling extensively in spite of the constraint of poor road infrastructure to the interiors in the rural India. The other notable MFIs in India are Spandana, AML, Bandhan etc. Success stories of these Microfinance Institutions in India prove the enormity of market potential which exists in India – huge and untapped in most of the areas. People are ready to pay higher interest rates provided they can avail themselves of the credit facilities in an effective manner.
One major advantage for the commercial banks over the NBFC-MFIs is the lower cost of capital. This enables the commercial banks to charge significantly lower interest rate compared to the microfinance institutions. The commercial banks are larger in size with huge manpower and wider presence across the country. Moreover, most of the commercial banks use technology extensively to improve operational efficiency. However, the lack of technology knowhow among the rural people nullifies much of this competitive advantage. Use of internet banking and mobile banking has little impact in the remote areas. For them, banking is more of a relation which has been utilised by the NBFC-MFIs like SKS. However, in the long run, with the improvement in educational level and electricity in the rural areas, the commercial banks can leverage their technological advantage to good use. Also, ever since reports of increased suicide in Andhra Pradesh, the Government has put stringent laws on the NBFC-MFIs in terms of loan recovery and provisioning. The Government banks are perceived to be more lenient in terms of loan repayment, with little or no history of forceful recovery. It is important to see whether the commercial banks can utilise this advantage to good use.
A good strategy for the commercial banks will be appointment of a team of local people to provide door-to-door services. The employees have to come out of the boundaries of the bank to create a bond with the borrowers. The rules laid down to offer loans to the poor people should be simpler and easier to comprehend unlike the current processes. The borrowers will also feel at ease if local people are recruited for value added service as there won’t be any language barrier. Similarly, for export credit, a possible value addition can be increase or decrease of export credit based on rupee fluctuations. According to Federation of Indian Export Organisations (FIEO), the share of export credit in total credit has reduced to 11.36% from 19.82% from 2007-08 to 2011-12. While the PSUs might incur short term losses for the same, higher export will lead to more dollar earning and hence reduced Current Account Deficit. Finally a differential interest rate on education loan can be provided to the different section of the society to promote education level. The current literacy rate of India is 82.14% for males and 65.46% for females, which is way below the statistics of developed countries. A differential interest rate will provide lot of encouragement to the weaker section to send their children for education.
The Indian banking industry received lot of accolades around the world for being resilient to the 2008-09 global financial crises. But there are opportunities galore to go a step ahead by providing inclusive growth to the society. Improvement in PSL will instil confidence among the weaker section as they will get loans at a cheaper rate. However, care should be taken that such advances are not misused by people other than the needy. The risk of NPA might also increase at certain times, but we believe the long term benefits will eventually win over short term losses. While fiscal measures like Food Security Bill will take care of primary needs, PSL will improve the structural weakness of the country in terms of education and employment. Recent rupee freefall has again pointed to the fact that Indian service led economy is still dependant on the West and any policy changes have detrimental effect on our country. Hence the people have to be made resilient to such external shocks by improving small scale industries, exports and education level. The issuance of new banking license will make the banking industry more competitive, and the existing banks have to use the early mover advantage by tapping the priority sector. Priority sector lending will remain a liability if banks remain short-sighted and follow their cliché methods of lending. It will become a plethora of opportunities the moment banks reach economies of scale in the remote areas. The success of the NBFC-MFI is an eye-opener to what the banking industry can achieve in the coming days. India is set to become the third largest banking industry in the world by 2025. But looking at the opportunities in the priority sector, we believe the target might be achieved at a date earlier than projected.