Pre-Budget Blueprint: Expanding MSME and Priority Sector Lending through NBFC-PSL

1. Banks’ inability to fulfill PSL mandates:

Despite the RBI’s mandate that 40 percent of Adjusted Net Bank Credit (ANBC) must be directed to PSL, many banks fail to meet this target. This is partly due to challenges in reaching underserved rural areas and sectors where risk perceptions are higher and credit delivery is less efficient.

2. Narrow definition of PSL:

PSL is currently focused on traditional sectors such as agriculture, education, and micro-enterprises. However, emerging sectors like green energy, renewable technologies, and digital infrastructure—key to India’s economic transformation—are not adequately covered.

3. Inadequate reach:

Banks often rely on priority sector shortfall deposits (PSL-DF) with NABARD, rather than expanding direct lending capabilities to underserved areas. This indirect approach limits the transformative impact of PSL on marginalised communities.

The case for NBFC-PSL

The introduction of NBFC-PSL as a dedicated category could resolve these challenges by:

• Expanding the definition of PSL: Include emerging sectors such as renewable energy, digital infrastructure, and women-led enterprises, aligning PSL with India’s long-term development goals.

• Bridging the gap in PSL compliance: Provide a reliable mechanism for banks to channel funds into PSL through NBFC-PSLs, which specialise in last-mile credit delivery.

• Focusing on underserved areas: Leverage digital platforms and innovative credit models to enhance access in rural and semi-urban regions.

Learning from NBFC-MFIs and HFCs

NBFC-MFIs have demonstrated the power of sector-specific regulations in achieving financial inclusion at scale. Clear guidelines for micro-lending have enabled these institutions to effectively serve low-income borrowers, addressing their unique financial needs. Additionally, access to concessional funding and PSL treatment has ensured a steady capital flow, allowing NBFC-MFIs to expand their reach and support underserved communities sustainably.

While HFCs (housing finance companies) have demonstrated the benefits of targeted focus leveraging PSL classification for small-ticket housing loans, they’ve played a critical role in achieving “Housing for All.”

Expanding PSL to 3x: The economic impact

Expanding PSL could be a transformative step in empowering MSMEs, boosting agricultural productivity, supporting emerging sectors, and increasing GDP contribution. MSMEs, which contribute 30 percent to GDP and employ over 110 million people, face significant challenges in accessing credit. Enhanced PSL support would provide the necessary funds for scaling operations, adopting new technologies, and boosting competitiveness, ultimately generating millions of jobs in underserved urban and rural areas. Similarly, small and marginal farmers could benefit from greater financial inclusion, enabling investments in seeds, technology, and infrastructure to increase yields and incomes. Extending PSL to emerging sectors like renewable energy, digital infrastructure, and skill development would align the financial system with India’s economic aspirations, fostering innovation and creating employment opportunities, especially in areas like green energy and electric vehicles. This comprehensive approach could potentially add 5-7 percent to India’s GDP by driving productivity, consumption, and innovation across key sectors.

Policy recommendations for Budget 2025

To operationalise NBFC-PSLs, the following measures are essential:

1. Expand the PSL definition - Include emerging sectors such as renewable energy, women-led enterprises, and digital infrastructure to reflect India’s evolving economic priorities.

2. Enable NBFC-PSLs as a distinct category - Establish a dedicated regulatory framework with clear guidelines on lending focus, compliance, and refinancing.

3. Strengthen PSL incentives for banks - Allow bank loans to NBFC-PSLs to qualify as PSL, ensuring a consistent flow of capital.

4. Concessional refinancing - Enable NBFC-PSLs to access low-cost funding from NABARD, SIDBI, and Mudra Bank, lowering lending costs for borrowers.

5. Credit guarantee schemes - Introduce government-backed risk mitigation mechanisms to encourage banks and investors to fund NBFC-PSLs.

6. Leverage technology for outreach - Encourage the adoption of AI-driven credit assessment tools and digital platforms for efficient last-mile credit delivery.

The transformational potential of NBFC-PSLs

The introduction of NBFC-PSLs has the potential to bridge the gap between policy intent and on-ground execution by enabling banks to efficiently meet their PSL mandates. It can significantly expand credit access to underserved communities, rural areas, and emerging sectors, fostering financial inclusion. Additionally, this initiative could accelerate employment generation and contribute to GDP growth, driving India’s overall economic development.

A call to action

The inability of banks to fulfill PSL mandates and the narrow definition of PSL have constrained its potential to drive inclusive growth. By introducing NBFC-PSLs, India has an opportunity to address these challenges and create a financial framework that supports its development aspirations.

As policymakers deliberate on the Union Budget 2024-25, NBFC-PSLs must emerge as a priority. By expanding PSL to 3x its current levels and redefining its scope, India can achieve transformative economic growth, creating jobs, empowering communities, and boosting GDP.

The time to act is now. Let NBFC-PSLs lead India into a new era of inclusive prosperity.

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