Priority sector continues to scare foreign banks

The priority sector lending targets are dissuading foreign banks from creating subsidiaries in India

Foreign banks' reluctance to create subsidiaries in India is known. Even a promise of near-national treatment in branch expansion has failed to convince them. Their biggest fear, it appears, is priority-sector lending (PSL) targets. This has prompted the Reserve Bank of India (RBI) to review the PSL norms for these banks, before persuading them to set up wholly owned subsidiaries (WOS) here.

Why are foreign lenders scared of PSL, particularly farm lending? “Most foreign banks' operations in India relate to wholesale and commercial banking. Their skill sets, resources and experiences are built around this type of business. Different skills, resources and experience levels will be required for these banks to undertake priority-sector/farm lending. Some of these banks do not transact such business in their home countries, so many are not familiar or comfortable with taking it on. Specific new governance and risk management may also need to be developed to manage and oversee these new business activities,” says Deepak Haria, senior director at Deloitte in India.

At present, Indian banks are required to achieve PSL target of 40 per cent of aggregate advances, with 18 per cent sub-limit for the farm sector. The same applies to WOSes of foreign banks. Foreign lenders with 20 or more branches in India are being brought on par with local banks in PSL targets, in a phased manner over five years starting April 2013. For foreign banks with less than 20 branches, the overall target is fixed at 32 per cent.

Experts believe the risks associated with farm lending are not well reflected in pricing of such loans. “Agriculture lending in India poses risks. These risks are not well priced and banks are not allowed to charge risk premium. So, not only are foreign banks shy, even public-sector banks’ performance in this space has not been encouraging,” says Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services.

Bankers claim politicians often use banks’ PSL for their own benefits. Waiver of agricultural loans is one such example; it poses serious credit quality risks for banks. For instance, the incumbent governments of Andhra Pradesh and newly formed Telangana recently promised waiver of farm loans.

“(This) can significantly impact the credit culture among the agricultural communities in these two states. More importantly, as these schemes seem to yield electoral gains, similar announcements could be made in other states as well. The most vulnerable would be states that are about to go to polls,” Prakash Agarwal, associate director at India Ratings, said in a recent note to clients.

Also, to meet PSL targets, foreign lenders need to expand their reach in rural geographies — an idea that does not impress many.

“Agriculture lending has posed problems for the entire banking sector. Over the past decade India's GDP has grown by eight per cent while agriculture sector has only grown by four per cent...The situation becomes even more difficult (for foreign banks) since this kind of lending requires deeper reach in rural areas and specific local understanding for better risk management and credit appraisal,” Shashwat Sharma, partner – management consulting at KPMG in India, said.

At present, close to 99 per cent of foreign bank branches in India are in metropolitan centres. Bankers say rural branches take more time to break even and suffer from connectivity issues; also, finding people to man those is often difficult.

“I think the whole idea of pre-determined buckets within which loans need to be booked to qualify for priority sector, with its attendant eligibility conditions that are quite intricate, is a challenge for all banks. Foreign banks have a further disadvantage because of their inability or unwillingness to scale up, lack of local credit infrastructure capable of managing diverse retail portfolios and the difficulty of selling the idea of doing local business in foreign jurisdiction,” says Shinjini Kumar, leader (banking & capital markets) PwC in India.

The prescriptive nature of PSL guidelines also pose challenge for foreign lenders. "There are banks that genuinely want to do local business as their home markets may be saturated. But even they find it a challenge in the absence of infrastructure and opportunities for good credit selection in the rural and micro enterprise space. If the rural economy was to become attractive, such banks would find a way to finance rural growth as well. But then again, the PSL guidelines are prescriptive and sometimes a bank – domestic or foreign – could be financing something relevant to rural economy and still not qualify for PSL," Kumar said.