This post is a continuation of IFMR Finance Foundation’s blog series on the different aspects of the Report of the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households.
By Anand Sahasranaman, IFMR Finance Foundation
In view of the rigid sectoral targets and the absence of an active trading market for PSL assets, current PSL requirements force identical strategies from all banks, with little scope for specialisation.
The sectors qualifying for PSL have been updated by the RBI from time to time. Within the overall sectoral definitions prevalent currently, there are also sub-targets for some sectors: for instance, there is a target of 13.5% of Adjusted Net Bank Credit (ANBC) to Direct Agriculture, 4.5% of ANBC to Indirect Agriculture, and a target of 10% of ANBC for credit to Weaker Sections. Analysing the performance of banks in meeting these sub-targets reveals that meeting the Direct Agriculture sub-target has consistently proven to be a challenge for the banking system, with a 25% shortfall in achievement against the stipulated target. Additionally, the banking system overall also falls 10% short of achieving the Weaker Sections target.
In addition to the sectoral dimension, there is also significant regional disparity in the disbursement of PSL credit. Southern and western states have traditionally benefitted from PSL disbursements, while the central, eastern and north-eastern states have been neglected. During the 11th Five Year Plan, 37.6% of agricultural credit was disbursed in Southern India, which accounts only for 18.7% of India’s gross cropped area. On the other hand, Eastern India received only 7.3% of agricultural credit with 14.7% of gross cropped area and Central India received only 13.2% of agricultural credit with 27.2% of gross cropped area.
In view of the challenges banks face in achieving PSL targets in some sectors and regions, and in order to ensure that banks have the incentive to specialise while achieving these targets, the CCFS has recommended the Adjusted PSL (APSL) mechanism. Under this mechanism, while there is no change in the underlying sectors eligible for PSL, there is additional weightage given to lending to the more difficult sectors and districts. The target for banks is to reach an APSL of 50% by lending to any combination of PSL sectors and districts they choose.
As discussed earlier, Direct Agriculture and Weaker Sections are two PSL sectors that have seen shortfalls in lending, and based on the historical extent of shortfalls, there is additional weightage now provided under the APSL mechanism, as follows:
As the table indicates, Rs.1 lent by a bank for direct agriculture would be multiplied by a factor of 1.25, and the Adjusted PSL achievement would be equal to Rs.1.25
In addition to PSL sectoral weightages, regional discrepancies have been addressed through district-level weightages which are based on the extent of financial inclusion in each district, as per the Crisil Inclusix Index. Scores in the index range from 96.2 for Pattanamthitta district in Kerala to a low of 5.5 for Kurung Kumey district in Arunachal Pradesh. A raw district weightage for each district is calculated based on the distance of the score for that district from that of the best performing district, i.e., the worst performing district would have the highest weightage. However, in order to ensure that the district weightages do not become too high, they need to be damped down by a factor which is calculated such that the district with a CRISIL Inclusix score of 50 gets an APSL of 50% for achieving 40% ANBC with the current sub-targets within PSL.
The combination of district and sector weightages will determine the overall APSL applicable for each bank’s PSL portfolio.
As the table illustrates, each district-sector combination has a weightage attached to it which is based on the individual weights of that district and that sector. For instance, Rs.1 lent by a bank for direct agriculture in Faridkot district would be multiplied by a factor of 1.41, to get an APSL achievement of Rs.1.41. It is also apparent that the APSL mechanism does not in any situation result in weightages of below 1, meaning that Rs.1 invested by a bank in any PSL asset in any district would at least yield an APSL of Rs.1.
Overall, the implication of the APSL mechanism is that it will be the strategies of individual banks that will determine the fraction of ANBC they will need to lend as PSL – the only stipulation being that each bank will need to achieve a target APSL of 50%.
This is clarified through the following illustrations of 3 banks following distinct PSL strategies to reach an APSL target of 50%:
1. BANK 1 lends equally across 3 districts – the most financially included district, the least financially included district, and the district with the middle score in the Crisil Inclusix index. Its PSL portfolio follows all the sub-target norms as per current PSL requirements. This bank will need to lend 40% of ANBC to reach the APSL target of 50%.
2. BANK 2 lends only for Direct Agriculture in the least financially included district, and will need to lend only 32% of ANBC to reach the 50% APSL target.
3. BANK 3 lends only for SME Export in the most financially included district, therefore needing to lend 50% of ANBC to reach 50% APSL.
In conclusion, the APSL mechanism is designed with the intent of promoting increased specialisation among banks by incentivising lending to the more difficult regions and sectors and by enabling banks to follow distinct strategies in reaching the APSL target.