Commercial banks’ priority sector lending for 40 years has had limited success. It’s time for a complete overhaul

After nationalisation of a number of large banks, mandatory lending to priority sectors served the purpose for which it was intended. But the entire process was subsequently torpedoed by the political class; the rural population was exploited for political gains and these banks are now saddled with mounting non-performing assets

Since nationalisation of banks in 1969, commercial banks have been asked to lend a certain percentage of their lendable resources to what is called as the ‘priority’ sector, with a view to provide an opportunity to the poor and the underprivileged section of our society to improve their standard of living by venturing into productive vocations. This lending to the priority sector under the directions of the Reserve Bank of India (RBI) was also intended to replace village moneylenders, who charged exorbitant rates of interest by providing need-based loans at ‘reasonable’ interest rates.

The intentions with which directed lending was implemented were laudable, as it helped in meeting the financial needs of the agriculturists and the village artisans to a considerable extent, and paved the way for transformation of the village economy substantially during the past (over) four decades. While in the initial years of introduction, mandatory lending to priority sectors served the purpose for which it was intended, subsequently, the entire philosophy was torpedoed by the political class and became an instrument of exploitation of the rural population for political gains, at the cost of the lending banks, who with a view to appease their masters quietly swallowed the bitter pill, notwithstanding the consequent adverse effects it had on the health of the banking institutions of our country.

The Central government too added fuel to the fire by resorting to populist measures like periodically announcing waiver of loans granted by banks to agriculturists, among other measures. These debt-waiver schemes virtually encouraged loan defaults that eroded the loan repayment ethics and thus ruined the basic tenets of lending, causing irreparable damage to the economy of our country. This resulted in some of the public sector banks going into the red and when they reached a level of negative net worth, they were bailed out by the Central government from taxpayers’ money, though it resulted in bloating the Budgetary deficit, year after year.
Against this background, the first Narasimham Committee report in 1991 recommended a fresh look into the subject of priority-sector lending by banks and made concrete recommendations to phase out the directed lending slowly, to ensure growth of the banking industry on healthy lines. The views of the Committee on these issues were as under:

“With respect to directed credit programmes, the committee is of the view that they have played a useful purpose in extending the reach of the banking system to cover sectors which were neglected hitherto. Despite considerable unproductive lending, there is evidence that the contribution of bank credit to growth of agricultural and small industry has made an impact. This calls for some reexamination of the present relevance of directed credit programmes, at least in respect of those who are able to stand on their own feet and to whom the directed credit programmes with the element of interest concession that has accompanied it, has become a source of economic rent.”

The Committee recognizes that in the last two decades, banking & credit policies have been deployed with a redistributive objective. However, the Committee believes that the pursuit of such objectives should use the instrumentality of the fiscal rather than the credit system. Accordingly, the Committee proposes that the directed credit programmes should be phased out”: (Source: The Narasimham Committee Report, 1991).

However, the RBI did not accept these recommendations for obvious reasons, but made some modifications to the priority sector lending guidelines, and continued with the policy of target-oriented priority sector lending not only by the domestic banks, but also by foreign banks operating in the country. The RBI went a step further and introduced penalty for banks that were not able to reach the stipulated targets by asking them to deposit the differential amounts in the low-yielding Rural Infrastructure Development Fund (RIDF) set up by the National Bank for Agriculture and Rural Development (NABARD) or such other institutions stipulated by RBI. The banks who lent to the priority sector and reached their targets suffered on account of rising non-performing assets (NPAs) in their books, and those who failed to reach their targets suffered by having to invest in low-yielding funds mentioned above. It has been, therefore, a no-win situation for the commercial banks, who meekly submitted to the dictates of RBI for the simple reason that they had absolutely no say in the matter and they were virtually required to either put up or shut up, which they did with great aplomb in their own enlightened self-interest.

The policy of target-oriented lending has its own drawbacks, and it resulted in undesirable practices in many banks, causing accumulation of NPAs by these banks. The objectives with which these policies were framed were defeated due to faulty implementation, as a sizeable amount of bank loans did not reach the right beneficiaries, or these loans were not used for productive purposes, though the records maintained at branches of banks showed a contrary picture. The cat was out of the bag only when these loans became bad and the bank inspectors reported lot of irregularities in sanctioning and monitoring of these loans both at the grass-roots level and at the level of controlling offices as well.

The statistics provided by RBI points out a picture of increasing NPAs out of priority sector loans, as reflected in the following table:

In short, what is generally happening today in commercial banks is that they show lip sympathy to these priority sector borrowers, and lend money a bit reluctantly, only because of the pressure from the top, without any real commitment on the part of the rank and file to improve the lot of the poor and the underprivileged members of our society. The main reason for this attitude is due to the fact that branch managers are neither trained adequately in the art of lending to the priority sector nor are they being protected when the loans go bad for reasons beyond their control. And in hindsight, any decision of the branch manager can be questioned and found fault with, more so because today’s bank manager is required to perform multifarious functions from banking to insurance, mutual funds, investments and wealth management etc. apart from lending to the priority sector.

Despite all the technological improvements in the agricultural sector, it continues to be dependent on the rain gods and the vagaries of the monsoon play havoc with the poor farmers in our country. The reports of farmers heavily in debt committing suicide due to failure of crops and their inability to honour their commitments are heart-rending, and these require a dedicated band of bank offices who can understand and appreciate the plight of these farmers and play a role of a friend, philosopher and guide to the distressed farmers.

This calls for an attitudinal change at all levels in all commercial banks. The question is how to bring about this change in the present context of change in value systems and the need to develop our banks on sound lines to respond to the growing needs of our economy.

The answer to this question and the strategy to give a greater thrust and focus to the priority sector lending without hurting the banks is the subject of Part-II of this article, which will appear tomorrow.
(The author is a banking and financial consultant. He writes for Moneylife under the pen name ‘Gurpur’).

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