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Sustaining Nation’s Priority through Priority Sector Lending Certificates (PSLCs) – An Innovative Approach

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Priority Sector:

  1. Priority sector refers to those sectors of economy which may not receive timely and adequate credit in the absence of special dispensation.
  2. Sectors which “impact large sections of the population, the weaker sections”
  3. Sectors which are “employment intensive such as agriculture, Micro, small and medium enterprises”
  4. Sectors which meets the basic needs of a common man
  5. Sectors which contributes more to GDP of country

Background:

  1. In National Credit council meeting held in July 1968, it was emphasized that commercial banks should increase their involvement in financing priority sectors
  2. The description of the priority sectors formalized in the year 1972 as per Informal study group on statistics relating to priority sector advances constituted by RBI in May 1971
  3. In November 1974, banks were advised to raise the share of priority sectors in their aggregate advances to the level of 33 1/3 % by March 1979. This was later revised on the recommendations of Dr. K.R. Krishnaswamy Committee; and In March 1980, all commercial banks were advised to achieve the target under Priority Sector Lending (PSL) 40 percent of aggregate bank advances by 1985
  4. An internal working group under the chairmanship of Shri C.S. Murthy examined the concept of Priority Sector, targets and sub-targets. (wef.30.04.2007)
  5. Reserve Bank of India in August 2011 set up a committee to re-examine the existing classification and suggest revised guidelines (Chairman: Shri M V Nair).Some of the recommendations were accepted with effect from July 20, 2012
  6. An Internal Working Group (IWG) was set up in July 2014 under the chairmanship of Lily Vadera to revisit the existing priority sector guidelines. Based on the recommendations and comments received from various stake holders the revised guidelines on priority sector are laid down with effect from April 23, 2015

Components of Priority Sector:

  1. Agriculture
  2. Micro Small ANC Medium Enterprises
  3. Education
  4. Housing
  5. Export Credit
  6. Social Infrastructure
  7. Renewable energy
  8. Other Priority Sectors
  9. Investments by banks in eligible securitized assets
  10. Transfer of assets through Direct Assignment/outright purchase
  11. Inter-bank participation certificate
  12. Priority Sector Lending Certificates (PSLCs)

Benchmarks stipulated by RBI:

Sl No Parameter Benchmark
1 Total Priority Sector Advances 40% of ANBC
2 Total Agriculture

W/W Small & Marginal Farmers

 18% of ANBC

08%
3 Advances to Weaker Section 10.00% of ANBC
4 Lending to Women Beneficiaries 05.00% of ANBC
5 Lending to Micro Enterprises 7.50 % of ANBC
6 Lending to Minority communities 15.00% of Priority Sector Lending

 

For domestic and foreign banks with 20 branches and above the targets under priority sector are at par now. Foreign banks with less than 20 branches are required to achieve the total priority sector target of 40 percent of ANBC or CEOBE, whichever is higher, in a phased manner by 2020. Further banks have also been directed to ensure that their share of lending to non corporate farmers does not fall below the system wide average for the last three years of direct lending to non-corporate farmers

Non achievement of Benchmarks:

  • Shortfall in lending to priority sector target/sub-target on the above mentioned parameters shall be allocated amounts for contribution to the Rural Infrastructural Development Fund (RIDF) established with NABARD and other funds with NABARD/NHB/SIDBI/MUDRA and other financial institutions as decided by RBI from time to time
  • The deposit under various funds will be called upon by NABARD or such other Financial Institutions as per the terms and conditions of the scheme
  • From 2016-17 onwards, the achievement will be arrived at the end of financial year based on the average of priority sector target / sub- target achievement at the end of each quarter
  • Interest rates on RIDF is inversely proportional to the shortfall in achieving benchmark levels
Agricultural credit shortfall to ANBC Applicable Rate of Interest
Less than 5 % Bank Rate- 2%
Over 5% and up to 10% Bank Rate-3%
Over 10 % Bank Rate – 4%

(RBI circular dated 10.12.2014)

  • Non-achievement of Priority Sector targets and sub-targets will be taken in consideration while granting regulatory clearances/ approvals

Priority Sector Lending Certificate (PSLC):

Background:

The Raghuram Rajan Committee on Financial Sector Reforms had, inter alia, recommended introduction of “priority sector lending certificates (PSLCs)” to implement the priority sector lending in the country. The Committee believed that the process by which the priority sector mandates are implemented should be reformed to emphasize efficiency and ease of compliance, and once the new process is in place, the mandate should be strictly enforced. The focus should be on actually increasing access to services for the poor regardless of the channel or institution that does this—large banks may or may not be the best way to reach the poor, and while the mandate may initially force them to pay. Hence, the PSLC scheme was recommended by the Committee.

The criteria suggested by the Committee for certification (say by NABARD or its agents) would simply be whether the loan is to an eligible sector, whether the interest rate follows the norms below including transparency, and whether the loan duration is greater than 180 days. After an initial period of verification, institutions should be allowed to self-certify, with periodic random monitoring to ensure adherence to criteria. Separate certificates could be issued for enforceable sub categories (e.g., agricultural credit, weaker section lending, Micro enterprises, small and marginal farmers etc), and these may carry a different price.

A market (E-Kuber) was opened up for these certificates for buying and selling. In the PSLC market, the banks deficient in priority sector lending target can buy certificates to compensate for their shortfall in lending. Importantly, the loans would still be on the books of the original lender, and the deficient bank would only be buying a right to undershoot its priority sector-lending requirement/target by the amount of the certificate. If the loans default, for example, no loss would be borne by the certificate buyer.

If Banks find priority sector lending is unprofitable, there will be a high price for the certificates in the market and it is expected that more lenders will be attracted towards priority sector lending. If the price is low or zero after the market is given time to stabilize, it would mean that priority sector requirements, as set, are not onerous. All the entities lend to eligible categories in the priority sector may be offer PSLCs. Banks with shortfall of priority sector obligations may be allowed to buy the PSLC and submit it towards fulfillment of their target.

At present the domestic and foreign banks are having different priority sector lending targets.

The Foreign banks may not have the branch infrastructure to provide agricultural credit. The Priority Sector Lending Certificate scheme will help them bear their share of obligations without a branch network. Given the magnitude of need to provide credit to undeserved segments/poor, all banks may be obligated to uniform priority sector lending.

The PSLC provides market-driven interest subsidy to those who make priority sector loans. In case NGO and other charitable institutions want to participate in financial inclusion, they may be allowed to enter and buy in this market. The Government can play role to facilitate this market by purchase of certificates or stabilizing the price of certificate or by specifying its target volume of purchase etc.

The PSLCs are different from the Inter-bank participation certificates (IBPCs). The IBPCs are a form securitization of loans through which a bank buys the assets of another bank for a stipulated period. In IBPCs, the buyer has to take on the credit risk of the loans, which is high in the case of the underserved priority sector. Further, the loans are to be securitized have to be standardized, well documented, and serviced. This may also be a problem in case of loans to the needy and poor.

Priority Sector Lending Certificate (PSLC):

It is an eligible tradable instrument for achieving priority sector targets. The buyer (a deficient bank) will pay a ‘price/fee’ to the seller bank (a bank which has over achieved its PSL requirements) for purchasing a specified amount of PSL obligation applicable for a particular date.

Objectives:

  • To enable the banks to meet PSL requirements and allow leveraging of their comparative advantage
  • To give an option to the banks to come out of the investment under RIDF (earns low returns to the banks)
  • To allow a more efficient implementation of the priority sector lending mandate
  • To separate the objective of transferring priority sector obligations from the credit risk transfer and refinancing aspects, which are co-mingled in the Inter Bank participation certificates (IBPC)
  • To create innovative ways of earning fee based income to banks

Benefits:

  • PSLCs will make credit available at optimal cost due to market driven pricing mechanism
  • No risk sharing mechanism, the loan would continue to be on the books of the original lender
  • It removes unnecessary price arbitrage and inefficiency that bilateral transactions as exists in IBPCs
  • It increases fee based income to the bank (Seller) and thereby increases the profitability to the banks
  • It adds efficiency in meeting the targets on priority sector lending
  • It creates a deep and liquid forward market
  • No need of investing under RIDF due to which drain on the bank’s profitability
  • Getting regulatory clearances/approvals from RBI/NABARD etc is easy
  • It creates a kind of competition among the banks
  • It indirectly enhances the credit culture among the banks
  • No additional cost associated with managing such assets
  • Saving on the part of acquiring bank as servicing fee for managing such assets gets eliminated
  • No maximum limit or ceilings on the amount of PSLCs that could be purchased for achievement of various targets

Scheme features:

Parameters Features
Purpose To enable the banks to achieve the PSL target and sub targets by purchase of PSLCs in the event of shortfall and at the same time incentivize the surplus banks
Nature of the instruments The seller will be selling fulfillment of priority sector obligation and the buyer would be buying the same. There will be no transfer of risks or loan assets
Operational guidelines Available in CBS portal (e-kuber) Of RBI
Sellers/Buyers Scheduled Commercial banks (SCBs), Regional Rural Banks (RRBs), Loca Area Banks (LABs), Small Finance Banks (SFBs) and Urban Co-operative Banks who have originated PSL eligible category loans
4 Types of PSLCs PSLC Agriculture, PSLC Small and Marginal Farmers, PSLC Micro Enterprises, PSLC general
Computation of PSL achievement Sum of outstanding priority sector loans and the net nominal value of te PSLCs issued and purchased
Amount eligible for issue Up to 50 percent of previous year’s PSL achievement without having the underlying in its books.
Credit Risk No transfer of credit risk as there is no transfer of tangible assets or cash flow
Expiry date All PSLCs will expire by March 31st  and will not be valid beyond the reporting date (March 31st ), irrespective of the date it was first sold
Settlement Through e-kuber portal
Value and Fee The nominal value of PSLC will be the equivalent of the PSL that would get deducted from the PSL portfolio of the seller and added to the PSL portfolio of the buyer. The buyer would pay a fee to the seller which will be market determined
Lot size Standard lot size of Rs. 25 lakh and multiples thereof
Accounting Buyer – Fee paid will be an Expense, Seller – fee received will be a Miscellaneous income
Disclosures Both buyer and seller shall report the amount of PSLCs (category wise) sold and purchased during the year in the “Disclosure to the Balance Sheet”

Flow Chart:

Market consists of all banks who could be either issuers or buyers

All market participants would register on e-kuber plateform where PSLCs would be bought and sold and further traded

Issuer (A) assumes that he will have a surplus of Rs. 100 crore in his PSL –Agri achievement which is within 50% of last year’s PSL achievement and issues a PSLC for Rs. 100 crore with a specific maturity date and posts it on the posts it on the plateform

Issuer A sells the PSLC to buyer B at Rs. 10 crore and credits P&L with Rs. 10 crore. Buyer B debits P&L for Rs. 10 crore

A will subtract the value of the PSLCs issued, (in this case Rs. 100 crore) from its PSL achievement and report accordingly to RBI on reporting date

B can claim Rs. 100 crore worth of fulfillment of PSL obligation in case he holds the PSLC on the reporting date

B finds he has no shortfall and therefore trades / sells on the platform to buyer C after 80 days at Rs. 12 crore. B credits P &L and C debits P & L for Rs. 12 crore

A finds he has over estimated his PSL achievement and he has a Rs. 50 crore shortfall in PSLC obligation by virtue of having to subtract this Rs. 100 crore – he purchases Rs. 50 crore worth of PSLC from issuer D for Rs. 7 crore and adds Rs. 50 crore to his PSLC achievement

On the day of reporting to RBI,
A has subtracted Rs. 100 crore (PSLCs issued) but then added Rs. 50 crore (Purchased) to his PSL achievement
B can no longer claim any PSLC benefit
C adds Rs. 100 crore (purchased) to his PSL achievement
D subtracts Rs. 50 crore (issued) from his PSL achievement

Conclusion:

Once upon a time Priority sectors Lending was considered as neglected sectors of economy. It is well known fact that these sectors contribute a lot for the growth of an economy. Due to one or the other reasons, most of the banks finds difficult in achieving the benchmarks stipulated by Reserve Bank of India under PSL. We all know that resources available to the banks are not uniform everywhere and expecting everyone to achieve the uniform benchmarks under priority sector lending resulting in shortfall in achieving PSL targets. Issue and purchase mechanisms of PSLCs are very good opportunity for the banks not only in achieving the targets under PSL but, very good fee based income to the seller banks which ultimately increases the profitability to the banks.

Banks are somewhat comfortable in achieving Priority sector lending targets after the issue of revised guidelines on priority sector lending guidelines with effect from 23.04.2015. No doubt that financing to PSL sector by the Indian banks brought a change in the economy, yet it is not free from some issues and inconveniences. It is the long awaited need of the hour that banks have been given an innovative creative approach by the regulators in achieving the PSL targets which will facilitates banks in sustaining nation’s priority.

References:

  1. A Hundred Small Steps –Chapter5 on the Report of the committee on financial sector reforms 2008
  2. C S Saurav Malpani, Priority Sectors lending Certificates – Long awaited need of the industry, March 3’2015
  3. RBI circular dated 07.04.2016 on ‘Priority sector lending certificates’
  4. RBI circular dated 07.04.2016 “RBI – launches portal for trading PSLCs”
  5. Sandeep singh, The Indian Express dated 12.04.2016 “Banking on reforms”
  6. fafral.org.in, speech delivered by U S Paliwal
  7. iibf.org.in

Bio data

U Sethupitchai

Chief Manager (Faculty), Union Bank of India,
Staff College, Kalkere post, Bannerghatta Road,
Bangalore – 560083

Office No- 080-22639036 | Mobile- 7204701395
Email: (Office): [email protected]
Email: Personal: [email protected]

Working as chief manager (faculty), Discipline In-charge: Rural and Agri. Business Department at Union Bank Staff College, Bengaluru. Working as a faculty since July 2011. Joined the bank on 10.04.1997 as Rural Development officer. Qualifications include: M.Sc. (Ag), CAIIB, MBA (HR), various certificate courses from IIBF, Diploma in Home loan finance, Diploma in international banking and attained Continuous Professional Development (CPD) status from IIBF.

My article on “Agricultural Lending in India – Trends, Issues and Strategies” published in ‘Sai Om Journal of Commerce and Management’

My article on “Agricultural lending – A Commercial Viable Profitable Business Proposition” published in Banking & Finance Journal in June 2016.

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