Vault Matters: Priority sector lending or profitable sectors lending?

Since PSL borrowers do not easily get access to credit, banks, especially those in the private space, end up pricing this product lucratively

What does the P in PSL stand for? The answer to this straightforward question is quite simple: PSL is an acronym for priority sector loans. By virtue of being a universal bank, there’s a need to set aside 40 percent of the total loan book to meet the PSL obligation.

But the way banks have been satisfying their responsibilities towards PSL in the last four years makes one ask if banks are truly doing justice to the ‘P’ in PSL. Lately, instead of priority these loans are being approached more from the lens of profitability.  The irony is that while banks do end up meeting the requirement set out by the Reserve Bank of India on PSL either through organic ways or by buying the PSL certificates and eligible instruments, most banks are leaning towards PSL loans that can yield better profitability as well.

In other words, the P in in PSL is taking a new meaning. Priority seems to be taking a back seat in comparison to profitability.

The nub of the matter

The problem with this approach is that these loans are said to target the underserved and unserved segments of the population, often known as the bottom of pyramid borrowers. PSL loans usually comprise agriculture loan, loan to farmers and small and marginal businesses, microfinance loans and so on. Since these borrowers do not easily get access to credit, banks, especially those in the private space, end up pricing this product lucratively. Thus it becomes a critical component of the profitability engine.

While one could argue that this is exactly what NBFCs do, the key factor which should set banks apart from non-banks is the cost of funds. Blended cost of funds for NBFCs is presently 7 – 9 percent depending on their credit rating. For banks, it is well within 6 or 6.6 percent. Banks also have a broader distribution network in comparison to non-banks given the regulatory mandate to have a certain number of branches in semi urban and rural areas. Yet, when it comes to charging for rate of interest, there is barely a difference between the two.

RBI’s misplaced assumption

A few years ago, the RBI harmonised norms on certain asset specific lending such as MFI loans and the objective was that with MFI loans becoming lender agnostic and more end use specific, it would infuse competition on rates and eventually interest rates will trend downwards favouring the borrower.

But that premise hasn’t played out; the converse seems to be today’s reality. Instead of banks passing on the benefit of low-cost of funds, their lending rates are almost at par with that of NBFCs.

In other words, PSL is a weapon in the bank‘s hand to hit two birds with one stone – that of growth and profitability. The second order impact of this is already visible across the low-income loans category in the form of over-leveraging, more evidently in the less than Rs 1 lakh ticket size.

RBI rolled out measures to curb unsecured lending last November and that is working out positively. Now, it needs to solve the problem of over-leveraging in the bottom of pyramid strata and for that the regulator must move to curb the pricing game playing out in this space. PSL loans were intended to serve the underserved and ensure that this category of borrowers shift to organised credit. The longer we let the problem of high interest rates fester, the social implication of this may become tough to reverse. Andhra Pradesh’s crisis of 2010 is a good reminder.