Home >opinion >online-views >Whose priority is it anyway?

An idea that preceded bank nationalization—in fact it was mooted to pre-empt it—has become a permanent and pervasive feature of Indian banking regulation. Priority sector lending has survived not only bank nationalization but also liberalization and globalization of the Indian economy.

It all started off with the need for “social control over banking" when socialistic economic methods and models captivated political thinking in the country. Interestingly, it was initiated by the Congress party in an All India Congress Committee Resolution in 1967. The idea being that social control of banks by the government would help allocation of credit to socially desirable sectors of the Indian economy.

As it stands today, priority lending is defined by an assorted set of criteria such as sectors, sub-sectors, activities, size of loans, income groups, social and religious categories. As a consequence even though this lending is a regulatory requirement, the identified sectors continue to be credit starved. Over the years, banks have found ways and means to meet these targets without genuinely lending to these sectors or groups.

While the continuation of priority sector lending is justified, there is need to re-examine not just the regulatory guidelines but the existing classification and methods as well.

The all important and simple question to be asked is: whose priority is it? One assumes it is the national economic priority. If indeed it is so, haven’t national priorities changed during the last 40 years to warrant a change in the classification made in 1972?

The identification of sectors carried out in the sixties and seventies was appropriate for those times. The economy was in the throes of food and foreign exchange crises. Hence directing credit into these sectors was critical then. Is it so now? Also, the policy instruments and options that the government now has to overcome such situations are more diverse and sharper than it had then. So shouldn’t what constitutes the priority sector be redefined substantially?

To start with, priority sector must be aligned with the Five-Year Plan, at least directionally, thereby linking various interventions by the government and be placed in a coordinated policy framework. Indeed, when priority sector lending was defined in 1972, it was in total alignment with the thrust of the fourth Five-Year Plan. Now, it bears no resemblance or relation to the 12th Five-Year Plan or its medium-term priorities. How can investment priorities and their financing be divorced from each other?

In the current context, the sectors that are constraining growth and which need to be given priority sector status are energy and natural resources and environment. Given the serious and binding raw material and energy deficits facing the country, activities such as acquisition of natural resource assets abroad, or loans for creation of fresh capacity in renewable energy should be a part of the priority sector.

In addition to sectoral criteria, the other issue that needs reconsideration is size of lending. Should that be a defining criterion? Small may be beautiful, but that doesn’t necessarily make big ugly. Even as greater weightage may be given to smaller loans in areas such as housing, priority sector lending ought to be size agnostic.

In any case, size criteria have been repeatedly bypassed by the banks. For instance, receivable financing of small road transport operators, which comes under priority sector lending is done by banks to non banking finance companies (NBFCs) to meet their regulatory obligations. For all practical purposes, for the bank, it is one large loan to an NBFC who has lent it at a usurious rate of interest to small operators.

The other important aspect is the spatial dimension of credit. With public investment on the wane, regional balance is a big distortion in the pattern of economic growth and incentivized financing of private investment should be used to redress this situation. Instead of bringing the 100 minority districts under the purview of priority sector, it may be better to declare the lending in most under-banked areas in the country, such as the resource rich North East and Jammu and Kashmir, as priority areas. Lending in any state that has a credit-to-deposit ratio of less than 25% could be a qualifying criterion.

Finally, one issue that needs serious reconsideration is the passing on of the shortfall of banks’ priority sector targets to the National Bank for Agriculture and Rural Development (NABARD) for on lending. At the moment, a large part of this is ploughed back into the system in the form of steeply priced plan loans to state governments for their rural sector developmental initiatives. This defeats the real purpose of regulated lending.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com

Also Read |Haseeb A. Drabu’s earlier columns

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