The RBI has recently constituted a committee to suggest revised norms with regard to priority-sector lending and related issues. Here’s some food for thought for the committee members and a few out-of-the-box suggestions to radically change the system prevalent today

Yesterday (10th October), we had written on how the entire process of priority lending had been torpedoed by the political class and how the rural population was being exploited, leading to these banks being saddled with a large number of NPAs or non-performing assets. (See: Commercial banks’ priority sector lending for 40 years has had limited success. It’s time for a complete overhaul ).

This is the second part of the article, where we explore the strategy to give priority sector lending a greater focus and thrust, without hurting banks, for the consideration of regulatory authorities.

The Reserve Bank of India (RBI) has recently constituted a committee under the chairmanship of MV Nair, Chairman & Managing Director of Union Bank of India, to reexamine the existing guidelines and suggest revised norms with regard to priority-sector lending and related issues. This article, therefore, provides some food for thought for the committee members and a few out-of-the-box suggestions to radically change the system prevalent today with the objective to encourage a dedicated and committed band of banking institutions who will continue to do trailblazing work in the area of uplifting the village economy and improve the lot of the most vulnerable sections of our society. This can be achieved in two distinct steps which are outlined here below.

The first step is to change the attitude of the commercial banks towards priority sector lending and the following steps are suggested to achieve this objective.  
                                                                                                   
1.    Every bank should train a band of senior- and middle-level employees in the art of lending to the priority sector, both agriculture and small-scale industry and they should continue to be encouraged to upgrade their skills in the latest developments in this area of lending.
2.    Instead of making available priority-sector lending facilities in all branches, every bank should set up specialised branches in all potential centres and extend priority-sector lending through these branches alone where trained manpower should be deployed to facilitate proper sanction and monitoring of these loans and advances.
3.  The RBI should dispense with the present system of target-oriented lending to the priority sector and banks should be given total freedom to lend to all deserving and productive enterprises according to their own norms of lending without spoon-feeding the banks in this regard.
4.    The present system of allocating 40% of lendable resources to the priority sector by every bank should not be insisted upon and all penal provisions for not achieving this level of lending to the priority sector should be withdrawn with a view to give a free hand to the banks to develop a portfolio of their choice in the interest of improving the asset quality of every bank.
5.    Instead of a penalty-based system which exists at present to penalise the banks who do not reach the stipulated targets, the RBI should come out with an incentive-based system to encourage lending to the priority sector, as an incentivised system will receive better receptivity at all levels, and this will provide the necessary thrust to priority-sector lending by banks. And the incentives could be broadly on the following lines.

a)   The incentives proposed could be on a staggered basis and inbuilt incentives can be provided for reaching a level of 20%, 30% and 40% of their lendable resources and incentives can be considered as under:

Branch licensing and the CRR /SLR requirements can be linked to these percentages.

b)    The staff working in those specialised branches lending to the priority sector can be provided with appropriate incentives based on the level of lending to the priority sector at each of these branches.

c)    A certain percentage of profit can be exempted from income-tax for those banks reaching these levels of lending to the priority sector.

d)    Any other incentive could be thought of to provide impetus for lending to the priority sector.
                                                              
6.    All subsidies now provided to banks for lending to certain priority sectors should be withdrawn, and in its place, appropriate fiscal incentives should be provided so as to minimise paperwork and misuse of the subsidy system.
7.    In order to encourage the staff of commercial banks to improve lending to the priority sector, the bank managements, particularly in the public sector, should also change their attitude and follow the basic principle followed by banks all over the world that “error of judgment is not negligence”. All loans granted by the branch managers should be viewed from this angle and appropriate protection provided to the operating staff when loans go bad due to reasons beyond their control. This will give the required comfort to staff at all levels and radically change their attitude towards priority-sector lending and help the banks to do a better job in this area of banking.
8.    The farmer community in our country requires a lot of counseling and the bank officers engaged in this activity should be trained in this art of providing advice and counsel whenever needed and consider the requests of the borrowers with a humane touch.

The second step required in this direction is to develop and nurture a few specialised institutions exclusively for lending to the priority sector and the following suggestions, if implemented, will serve this cause admirably.  

1.    NABARD (the National Bank for Agriculture and Rural Development) should be charged with the responsibility of financing the total agricultural operations in the country. To achieve this goal, all the Regional Rural Banks (RRBs) presently operating in our county should be handed over to NABARD and all the branches of RRBs should be the lending arms of NABARD for this purpose. The RRBs should be completely under the ownership and control of NABARD, whose entire direct-lending operations to agriculture and allied occupations should be routed though the branches of RRBs, which should be funded by NABARD to the extent necessary.
2.    NABARD should be repositioned as the exclusive agency for agricultural finance in the country and it should set up new RRBs in districts which are not covered by RRBs at present, so that within a period of the next five years, the entire country is brought under the jurisdiction of NABARD for lending to agriculture and all allied activities.
3.    The capital to risk weighted assets ratio (CRAR) of NABARD as on 31st March, 2011 was as high as 21.76%, which indicates that NABARD is more than adequately capitalised at present to take over this responsibility of funding the old as well as the new RRBs and the Central government should consider future requirements of capital to meet the increasing responsibilities bestowed on it.                                                                                     
4.    The second institution that requires complete reorientation is the Small Industries Development Bank of India (SIDBI), which should play a more aggressive and pivotal role for developing the small scale industries in India. This institution should be the nodal agency for directly financing the micro, small and medium enterprises (MSMEs) in India, with the added responsibility of continuing with the refinancing activities.
5.    SIDBI should set up a nationwide branch network, with the avowed objective of financing the entire requirements of small scale industries including their working capital requirements, so that the small entrepreneurs need not depend on multiple banks for their financial requirements as it happens today.
6.     SIDBI should initially set up its own full-fledged branches in all district headquarters all over India within the next three years and introduce direct financing of all viable MSMEs and other microfinance institutions as well.
7.    While the public sector banks are starving for capital, SIDBI has been sitting on a pile of capital with CRAR at 30.08% as on 31 March 2010. This only shows that this institution has a long way to go to achieve its objectives and a complete overhaul of its functioning is required to provide the necessary impetus to the development of small scale industries in India.
8.    With over 20 years of existence, SIDBI has been able to build a loan portfolio of just over Rs35,000 crore, a major portion of which has gone to refinance the banks and other financial institutions. The financial requirements of small scale industries in our country are quite large and hence a visionary approach is required by this institution to create an impact in the development of MSMEs, which can be a game-changer for the economy of our country.
9.    The present system of credit guarantees provided by the Credit Guarantee Corporation of India should be dispensed with and all commercial banks should be delinked from this guarantee institution as they no longer need such a guarantee. And this part of the institution should be handed over to SIDBI, which can enlarge the role of this organisation to provide guarantees to venture capitalists that provide seed capital to projects of those small scale entrepreneurs approved by SIDBI.
10. Commercial banks, will however, continue with lending to the eligible and desirable borrowers in all sectors including the priority sector as hitherto and benefit from the incentives offered in respect of lending to socially desirable sectors, but without any compulsion of having to lend a certain percentage of their lendable resources to any specified sector as prevalent today.    
                
With the proposed structural changes suggested above in the matter of lending to priority sectors, the following objectives will be achieved.

By enlarging the role of two specialised institutions—NABARD and SIDBI—in the area of agriculture and small scale industry respectively, the whole economy of our country will get the required momentum in meeting the financial needs of this priority sector and provide the much-needed thrust to improve the lot of the underprivileged sections of our society. This will also help in improving the village economy further and provide employment opportunities in the villages and smaller towns of our country. The present pitfalls observed in the system of lending by commercial banks to the priority sector would be eliminated, as these two all-India institutions will be dedicated in their cause, without being unduly perturbed by the valuation of their shares, as they are fully owned by the government of India.                                                           
Commercial banks, on the other hand, will be able to play a much bigger role in developing our economy, which is expected to be the third-biggest economy in the world shortly. In the context of GDP that is growing in the range of 7.5%-9% during this decade, the banks in our country will be required to gird up their loins to finance the growing needs of the economy. The Indian banking industry is underutilised, as the loan-to-GDP ratio at present is reported to be 53% in India whereas it is 56% in Brazil and 120% in China. Further, with the introduction of Basel III norms, Indian banks will require substantial additional capital, which they will have to raise from the capital market. The strengthening of the balance sheets of banks by improved profitability and lower non-performing assets (NPAs) will result in better valuations in the bourses which will only help the banks to easily raise the required capital and meet the needs of the growing economy without fully depending on taxpayers’ money coming from the government’s coffers.
                                                           
(The author is a banking and financial consultant. He writes for Moneylife under the pen name ‘Gurpur’).