Does govt need to set priorities for banks? Experts discuss

The recommendations were however not accepted in toto by RBI. Nothing changed under the new rules except it became more punishing for foreign banks.

To analyze the current rules, CNBC-TV18's Latha Venkatesh speaks to R K Bakshi, ED of Bank of Baroda, Ashwin Parekh Partner at E&Y and TT Rammohan, Professor of Banking at IIM Ahmedabad.

Here is an edited transcript.

Q: Do you really need the government to decide for banks 40% of where they lend, should not the market be doing that? Do we need a priority sector at all?

Rammohan: We need it for number of reasons which I think have been making it plain in the public debate over the past many years. One is that the priority sector includes very important components like agriculture in the small scale sector. Now agriculture maybe only about 20% of the economy but it has a large proportion of population still living on land, more than 55% and then the small and medium enterprises account for nearly 50% of our manufactured exports.

So, you need credit to go into these sectors and it is next to impossible to see why banks would be directing the requisite amount of credit to these sectors unless they are told to do so. This is because there are all kinds of opportunities waiting for banks right under their noses in the urban areas and semi-urban areas in which they operate.

If you accept that these sectors are vital to the economy and that banks are essentially a play in the economy then basically the long-term interests of banks to be making sure enough credit goes into these sectors.

Q: I buy that argument ideologically. Agriculture once was 50% of the economy, now in terms of GDP contribution it has come down to actually 14%. It is only when you count agriculture and allied activities you get even upto about 18% or so. Do you think that in the very list this 40% should get pared down to something like 14-15% and that is imposed a little more drastically rather than this 40%?

Bakshi: It is 14% agriculture contribution but we are talking of 40% for total priority sector, which includes industry, which includes home saving, other priorities like the soft skills education and other areas. So whether 40% is the right number, I don’t know but this doesn’t cover only agriculture. Whether there should be directed lending perhaps we have despite the maturity of the financial markets, credit allocation perhaps can be left to them. Perhaps we have not reached that maturity and there may always be a fear whether these sectors which are considered to be difficult to handle or maybe in remote areas they may not get their due share.

Having said that, the percentages should have some correlation to the amount wise contribution to the economy and productive needs. Productive needs must be met and they must be ensured to be met.

Q: I don’t get you, what exactly do you think the rules should say?

Bakshi: For example whether direct agriculture in the way it is now being defined should be 13.5%, whether there is an absorption capacity to that extent because I have not done any calculation but the percentages continue to be much lower in that. So is it a manifestation that banks are not lending or is it a manifestation that absorption capacity as of now is not that much there.

So, if the credit in the banking industry grows by Rs 1 lakh crore, Rs 13,500 crore should go to direct agriculture. If it were to grow by Rs 2 lakh crore, then direct should grow by Rs 27,000 crore. Whether that type of direct correlation is something or whether we can find another mechanism as to what are the productive needs of agriculture.