Increased risks for banks

Changes in priority sector lending should be revisited

The Reserve Bank of India (RBI) last week issued revised guidelines for priority sector lending by banks. The RBI has said the revised guidelines seek to increase the penetration of credit to previously under-covered areas and regions, focus on small and marginal farmers, and will up investment in health care infrastructure and in the renewable energy sector. The aims of the revisions to the priority sector guidelines are of course commendable. Nobody can question the broader desire to ensure that both vulnerable sectors and remoter regions are given the best shot at lending. Start-ups have also been brought under the micro, small, and medium enterprise fold and given some attention. But, overall, the changes to the guidelines — which clearly reflect the political mandate rather than banking stability — could be risky, and enhance the ongoing crisis of credit growth and loan performance in the nationalised banking sector in particular.

Consider the new attempts to deal with regional disparities. The RBI has ranked districts depending on per capita priority sector credit, and to dis-incentivise priority sector lending to the better-performing districts. This will not just cause progress in the areas that are serving as engines of growth in the country to stall, but it will raise questions about federalism once again — almost every district in Tamil Nadu, for example, will see lending “dis-incentivised”. If the broader concern is that agricultural credit in particular is being taken up by larger borrowers in semi-urban areas, that is one thing. But if some areas, for example, are seeing a better performance by renewable energy or infrastructure or other priorities, then it is a bad idea to dis-incentivise them. 

In general, agricultural credit policies need an overhaul, rather than this attempt to intensify what is already failing. As former RBI governor Urjit Patel has pointed out in his recent book, agricultural credit disbursement as a proportion of agricultural GDP has steadily increased in recent decades. Further, agricultural credit now occupies a larger proportion of priority sector lending — 43 per cent in 2016-17— than it did at the beginning of the century. What ails agriculture in India is not a shortage of credit. It is poor policy, a lack of access to markets, and the mandate to support too many workers in the absence of a coherent driver of industrial or manufacturing growth.

Nor is the expansion of priority sector lending to start-ups good news. It betrays a lack of understanding of how the start-up — and the venture finance — sector works. This is a sector in which the mortality rate is abnormally high. It needs to be funded by risk capital, not by banks. What processes can a bank put in place to lend to a sector where collateral is usually unavailable? In fact, bank debt would drag a start-up down and reduce the efficiency of the sector overall — and perhaps have the counter-productive effect of increasing the mortality rate. Whether it is the new regional requirements, the agricultural focus, or the extension of the priority umbrella to start-ups, these guidelines will further weaken an already febrile banking sector.