PRIORITY SECTOR LENDING BY COMMERCIAL BANKS

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PRIORITY SECTOR LENDING BY COMMERCIAL BANKS


A Review of Priority Sector Lending by Commercial Banks in India  Introduction To The Study

            Availability of cheap and adequate credit is a boon for the Economic Development of a country.  By providing credit to farmers, industries, traders and businessmen the economic progress can be achieved.  The banking system can influence economic growth by enhancing resources in the direction of national objectives and priorities.

            The banks play a very crucial role in the process of economic development and so the availability of banking infrastructure is considered as one of the prerequisites for rapid and balanced development of the country.  The banks in India have an important responsibility of chanalizing the funds with most important sectors to fulfill the predetermined objectives.  There is a rapid expansion in banking, deposit mobilization and credit development due to which there is change in the scope of banking operations.

Lending To Priority Sectors By Commercial Banks

            The concept of priority sector was evolved in the late sixties in order to focus attention on the need to ensure adequate credit facilities to certain neglected sectors of the economy particularly in the rural areas.  The involvement of banks in priority sector lending has grown considerably with special emphasis on opening branches in un-banked areas.

With a view to ensure flow of credit to the neglected sectors like agriculture and small scale industries, the concept of priority sector lending was evolved and commercial banks were advised to grant at least 40 percent of their total advances to priority sector comprising of agriculture, small scale industries, small road and transport operators, retail trade, small business, professional and self employed persons, education which stood at 14 percent of the total advances in 1969, increased to 46 percent as at the end of 1988.  And the percentage of advances to priority sector was 35 during 1997.

Side by side with the expansion of bank deposits, there has been continued expansion of bank credit reflecting the rapid expansion of industrial and agricultural output.  The banks are also meeting the credit requirements of industry, trade and agriculture on a much larger scale than before, just as bank deposits have expanded, bank credit too has expanded tremendously particularly since July 1969, from about Rs.4,700 crorers in 1970-71 to Rs.7,25,370 crorers during 2002-2003.

In recent years, bank credit has picked up smartly by around 20 to 21 percent per year and many factors have contributed to this:

  1. 1. Increase in credit facilities by  commercial banks  results in large reduction in reserve     requirements (CRR/SLR); 2. Release of impounded cash balances under incremental cash reserve ration (ICRR); 3.Sharp increase in food credit mainly due to increased food procurement operation; 4.Increased demand for credit from public undertakings and the large increase in export credit; and  5.Fall in the interest due to RBI’s cheap money policy – rapid expansion in bank lending for industry, for housing, for buying of cars etc,.

In the sphere of bank credit, however, some of the old abuses regarding bank lending are still to be met with.  For instance, bank credit is freely available to well established houses of industry and trade without much difficulty while the tiny and small businessmen really find it difficult to get credit from banks; even now, some powerful but unscrupulous speculators are able to use bank funds to corner shares and acquire control over companies.

            Before 1969 commercial banks had largely neglected agriculture on the ground that rural credit was to be undertaken by cooperative credit societies and banks.  Accordingly, they remained largely indifferent to the credit needs of framers for agricultural operations and for land improvement.  This was regarded as a basic reason for the failure of planning in the agricultural sector and consequently for the failure of general planning.  At the same time, as the banks were owned and controlled by big industrialists before nationalization, small industrial concerns and business units were ignored by banks.

            Soon after nationalization, the commercial banks were asked to be specially concerned with the financing of priority sector of agriculture, small scale industry and business and small transport operators, In course of time, other priority sectors were also added, such as retail trade, professional and self-employed persons, education, housing loans for weaker sections and consumption loans.

The rationale of priority sector lending was one of the causes for nationalization of the top 14 banks in 1969.  However, it was the Working Group on the Priority Sector Lending and the 20 Point Economic Programme chaired by Dr.K.S.Krishnaswami which clearly spelt out the concept:

            The concept of Priority Sector Lending is mainly intended to ensure that assistance from banking system should flows in an increasing manner to those sectors of the economy which though accounting for a significant proportion of the national product have not received adequate support of institutional finance in the past”.

The different segments of the priority sector are as follows:

1.      Agriculture

2.      Small Scale Industries

3.      Small Road and Water Transport Operators

4.      Retail Trade

5.      Small Business

6.      Professional and Self-employed persons

7.      Education

8.      Housing Finance

The Reserve Bank of India issued certain directives to the commercial banks regarding Priority Sector Lending.  Priority Sector Advances should constitute 40 percent of aggregate bank credit.  Out of priority sector advances at least 40 percent should be allocated to agriculture.  Direct advances to the weaker sections in agriculture and allied activities in rural area should form at least 50 percent of the total direct lending to agriculture.  Bank credit to rural artisans village and cottage industries should at least be 12.5 percent of the total advances to small-scale industries.  About 12 percent of bank credit should go to exporters.  The commercial banking system and particularly the public sector banks under the influence of the finance ministry and the ruling party politicians took to priority lending enthusiastically.

The total credit extended by the public sector banks to agriculture, small-scale industry and other priority sectors went up from Rs.440 crores in June, 1969 to Rs.1.71,190 crores in March 2002.  As a result, advances to priority sectors as percentage of total credit increased from 15 percent in June 1969 to 43 percent in March 2002.  The rate of progress was quite rapid soon after nationalization but later progress was more modest.  The relatively slow progress of advances to the priority sectors was due to the fact that the bank officials from top to bottom were not imbued with the new objectives of banking.  At the same time banks were also worried at the poor and unsatisfactory recovery performance of the agricultural and small sectors.

Table

PUBLIC SECTOR BANKS’ ADVANCES TO PRIORITY SECTORS:

AMOUNT OUTSTANDING     (Rupees in Crores)

Priority Sector

June 1960

June 1971

June 2002

March 2004

Agriculture

160

340

63,080

90,540

S.S.I

260

440

49,740

65,850

Other Priority Sector

20

130

53,710

1,07,440

Total P.S Advances

440

910

1,71,190

2,63,830

Total bank credit

3,020

4,080

3,96,950

7,64,380

Percentage of Priority Sector Advances to total bank credit

12

25

43

34

Source :-  RBI Annual Report 2003 – 04

The priority sector advances include small transport operators, self-employed persons, rural artisans etc., inclusive of funds provided by RRBs by their sponsoring banks, loans to software industry, food and agro-processing sector.  The initial enthusiasm in favor of priority sector lending gradually wanted because of certain concrete problems faced by the banking sector.

In their anxiety to reach the target of 40 percent, the banks went in for indiscriminate lending.  In many cases, there was external pressure too on the banking sector to lend to weaker sections.

As priority sector loans were small accounts, public sector banks were not able to monitor the distribution, follow-up and recovery of tiny loans.  This increased their costs on the one side and aversely affected their profitability, on the other.  The commercial banks were squeezed in both ways.  On the other hand, they were forced to keep a high proportion of their deposits as much as 53.3 to 55 percent in liquid reserves till 1992 under CRR (15%) and SLR provisions (38.5%).  They had, therefore, only about 45 percent of the deposit resources for loans and advances.

            Even out of these limited 45 percent deposit resources, banks were to allocate 40 percent of their available resources, as loan to the priority sector.  What was still worse was that much of the priority sector lending has to be at a low concessional rate of interest.  The result was that the banking sector was unable to satisfy the credit requirements of other sectors.  At the same time, their profitability was squeezed badly and most of the banks incurred huge losses.

The bank lending to priority sector was not uniform in all states.  Actually, it was quite low in many backward states like UP, Bihar, Rajasthan etc.  In order to attain 40 percent of the target for the country as a whole, the banks were stepping up their loans to the priority sector in the more advanced states.  This further worsened the regional imbalance in the country. 

The Narasimhan Committee on the financial system, 1991 was against the continuance of the priority sector lending.  The Committee recommended to redefine the priority sector as follows.  It should be fixed at 10 percent of the aggregate bank credit.  It should be reviewed after a period of three years.  It should be completely phased out gradually.  The government of India did not accept this recommendation.  How ere, the panel of bankers constituted by the Indian Banks’ Association suggested to the Narasimhan Committee on Banking Sector Reforms (1998) that the present priority sector credit limit of 40 percent of the net bank credit should be slashed to 10 percent primarily for three reasons.   Operating expense for small loans was very high due to deployment of large number of field staff.  Success of recovery process was very low in agriculture and small scale sector, and Quality of assets was bad as there were too many risk factors.

  1. The government extending subsidies directly to the banks instead of routing them through intermediaries.

The bankers’ panel also suggested that the interest rate on priority sector lending should be deregulated and the banks be allowed to fix their own rate of interest depending on the cost of funds, risk cost, administration and transaction costs and profit margin.  The panel argued that the identified priority sectors would not be starved of credit as banks would service them according to their expertise by lending at market-related interest rates.

In order to speed up recovery from the priority sector borrowers, the panel suggested that the disbursement target for various branches at the state and district levels should be linked to the percentage of recovery.  The panel has called for setting up a debt recovery tribunal for small loans and adequate legal support for recovery of assets.  Banks should also be empowered to take over assets in case of default.

         Side by side with the expansion of bank deposits, there has been continued expansion of bank credit reflecting the rapid expansion of industrial and agricultural output.  The banks are also meeting the credit requirements of industry, trade and agriculture on a much large scale than before, just as bank deposits have expanded, bank credit too has expanded tremendously particularly sine July 1969, from about Rs.4,700 corers in 1970-71 to 10,92,890 corers during 2004 – 05.An Analysis Of Trends In Priority Sector Lending By Banks In India

            Here, the trends in advances to priority sector and its various segments, bank-group wise achievements in priority sectors, activity-wise credit to various segments and its sub-segments, credit to weaker sections and credit extended under differential rate of interest scheme has been presented.  Further, the performance of banks in lending to priority sector and the targets set for them also have been analyzed.

Growth of Priority Sector Advances of Commercial Banks Excluding RRBs.

  1. The details relating to growth rates of priority sector advances and bank credit are given in the following table.        

Chart

Growth Rate of Outstanding advances to priority sector and Bank credit and share of  PS  advances to Bank Credit

A segment – wise analysis of credit extended by scheduled commercial banks to various segments of priority sector is presented hereunder.

Credit to Agriculture

            The number of accounts covered under agriculture in priority sector declined from 2.03 crore in 1995 to 1.99 crore in 2004.  However, outstanding advances to agriculture had increased substantially during the period from Rs,24,200 crore to Rs.99,302 crore, registering an average annual growth rate of 16.6 per cent.  Out standing advances to agriculture as a percentage of Net Bank Credit had recorded a negligible increase from 11.4 per cent as at the end of 1995 to 11.5 as at the end of 2004.

            The average annual growth of direct finance to agriculture was lower at 13.9 per cent during 1995-2004.  The share of direct finance to agriculture in total agricultural credit declined from 88.2 per cent in 1995 to 71.3 per cent in 2004.  Direct finance to agriculture as a percentage of NBC had also declined from 10.1 per cent to 8.2 per cent during  the above period.

          The share of credit for distribution of fertilizers and other inputs which was at 2.2 per cent in 1995 increased to 4.2 per cent in 2004.  The shares of other types of indirect finance to agriculture to total agriculture credit increased significantly from 4.8 per cent to 21.0 per cent during the said period.  As a percentage of NBC, other types of indirect finance to agriculture increased from 0.6 per cent to 2.4 per cent.

            Indirect credit to agriculture provided by banks, comprising of finance for distribution of fertilizers and other inputs and other types of indirect finance, grew at a rate of 30.8 per cent during the corresponding period[1].

It would be observed that the share of indirect credit to agriculture in total agriculture credit increased from 11.8 per cent in March 1995 to 28.7 per cent in March 2004 despite the fact that indirect agriculture advances are reckoned only to the extent of 4.5 per cent while measuring the performance of banks in achieving the target of 18 per cent of NBC in agriculture.  As a percentage of NBC, indirect credit to agriculture increased from 1.4 per cent to 3.3 percent during the above said period.

Chart

Percentage Share of Constituents of Agriculture Credit to

Total Agricultural Credit

Credit to Small-Scale Industries, Setting up of Industrial Estates and Small Road and Water Transport Operators.

  1. Such loans as a percentage of NBC were at a negligible level.

The average annual growth rate of advances to Road and Water Transport operators was at 12.7 per cent during 1995-2004 with per account outstanding amount at Rs.0.41 lakhs in 1995 visa-vis Rs.1.40 lakh in 2004 Loans to Road and Water Transport Operators as a percentage of NBC declined marginally from 1.4 per cent to 1.0 per cent.  The significant feature observed in this regard is the decline in the number of accounts in SSI and other sub sectors over the period, while the amount outstanding increased.  This shows that enhanced credit limits were granted to such units to meet their requirements.

Bank Group –wise Credit to Priority Sector

Public Sector Banks (PSBs)

The outstanding priority sector advances of PSBs increased by 21 percent in 2003-04 as against an increase of 18.6 per cent during 2002-03 .  During the period 1995-2004, the average annual growth rate of advances to priority sector by public sector banks was 17.6 per cent as compared to average growth rate of NBC at 16.7 per cent in the same period.  The higher growth in priority sector advances of PSBs during the above period was primarily due to 28.8 per cent average growth rate recorded by other priority sectors which compensated for the low average growth rate in credit to SSI (9.3 per cent) and direct agriculture credit (15.7 per cent).  The share of priority sector advances in NBC of PSBs increased to 44 per cent in 2003-04 from 42.5 per cent in 2002-03.  The growth in priority sector advances of PSBs was fuelled by the surge in the loans and advances to various other priority sectors and robust growth of credit to the agriculture sector (Chart 3).  Advances to agriculture constituted 15.4 per cent of NBC of PSBs as on the last reporting Friday of March 2003.  The share of advances to other priority sectors in NBC of PSBs increased to 17.0 percent in 2003-04 from 15 per cent in 2002-03.  The number of accounts covered under various major segments of priority sector declined over the period.

Table

PRIORITY SECTOR ADVANCES        

(Rupees in crores)

Month and Year

Public Sector Banks

Private Sector Banks

Foreign Banks

March 1998

91,319

(41.9)

11,614

(40.9)

6,940

(34.3)

March 1999

1,07,200

(43.5)

14,295

(41.3)

8,270

(37.1)

March 2000

1,27,807

(43.6)

18,348

(39.4)

9,699

(34.5)

March 2001

1,46,546

(43.0)

21,550

(38.1)

11,835

(34.1)

March 2002

1,71,185

(43.1)

21,530

(38.8)

13,414

(34.2)

Source: Report on currency and Finance, 2002.

Note: 1. Figure  in brackets are percentage shares in net bank credit in the  respective  groups.

  1.           2. The target for aggregate advances to the priority sector is 40 per cent of the net  bank credit for domestic banks and 32    

              percent of net bank credit  for the foreign  banks.

Chart

Share of Advances of Priority Sector

Advances and its Segments (Public Sector Banks)

Private Sector Banks

            Private sector banks’ lending to priority sector as a percentage of their NBC has been showing an increasing trend.  The share of their advances to priority sector in NBC had increased from 44.4 per cent in 2002-03 to 47.4 percent in 2003-04.  During the period from 1997 to 2004, average annual growth rate of priority sector advances of private sector banks was 29.5 per cent which was mainly contributed by the growth in lending to other priority sectors (44.7 per cent) and agriculture (37.4 per cent).  In comparison, the average annual growth rate for advances to SSI was at 8.4 per cent.  In absolute terms, credit to agriculture, SSI and other priority sectors had increased.

The share of credit to other priority sector category was the highest at 23.1 per cent of NBC, followed by advances to agriculture and SSI.  The lending of private sector banks to agriculture sector had increased to 12.3 per cent of their net bank credit in 2003-04, higher by 1.1 per cent over that in 2002-03.  The respective shares of credit to agriculture, SSI and other priority sectors in total priority sector advances of private sector banks over the period from 1996 to 2004 are presented in chart I.4.

 Chart

Share of Advances to Priority Sector and its Segments

(Private Sector Banks)

Advances to Weaker Sections

        As against the target of 10 per cent of NBC, achievement in purveying credit to weaker sections by PSBs was to the extent of around 7 per cent during 2001 to 2004.  In the case of private sector banks, the achievement, which varied between 1.70 per cent in the year 2001 and 1.34 per cent in 2004, had fallen short of the target considerably.

Table

Advances to Weaker Sections

As on Last Friday of March

Public Sector Banks

Private Sector Banks

Amount

(Rs. Crore)

% of NBC

% NPA

Amount (Rs. Crore)

% of NBC

% NPA

1

2

3

4

5

6

7

2001

24805.33

7.28

22.51

958.94

1.70

19.72

2002

28974.90

7.30

21.71

1142.06

1.82

10.30

2003

32303.75

6.76

19.39

1223.40

1.48

16.78

2004

41588.64

7.44

18.90

1495.49

1.34

12.15

Source: Report on Trend and Progress of Banking In India

Advances Under Differential Rate of Interest (DRI) Scheme

       The scheduled commercial banks are  required to extend advance under DRI Scheme to the weakest of the weaker sections at a rate of interest of 4.0 per cent.  A target of 1.00 per cent of outstanding amount of bank credit as at the end of Matrch of previous year has been fixed under DRI scheme.  As against this, the public sector banks had attained a level of only 0.07 per cent as at the end the year 2004.  The achievement, in percentage terms, had been declining persistently over the period.   The number of beneficiaries and outstanding amount of loans have also declined over the years.  However, the amount outstanding increased marginally in 2004.

Table

Advances of Public Sector Banks under DRI Scheme

As on Last Friday of March

No.of Accounts in Lakhs

Amounts outstanding (Rs. In Crore)

Total Bank Credit (Rs. In Crore)

DRI Advances as a % of Total Bank Credit

1

2

3

4

5

1995

19.47

683

138648

0.49

1996

15.52

678

165377

0.41

1997

14.30

655

193963

0.34

1998

9.05

544

197186

0.28

1999

7.29

485

233852

0.21

2000

5.90

422

265554

0.16

2001

5.14

358

316446

0.11

2002

NA

NA

341292

NA

2003

3.70

299

396953

0.08

2004

3.68

315

477899

0.07

Source: Statistical Tables Relating to Banks in India

Bank –wise Frequency Distribution of Targets and Achievements

        The frequency distribution in various ranges of achieving the target for priority sector advances as a percentage to NBC as on March 2004 is given in the following table.  Out of 27 public sector banks, only nine banks achieved the target of 18 per cent relating to credit to agriculture.  Among private sector banks, only 11 out of 30 banks had attained the target.  As regards the achievement of target in respect of credit to weaker section (10 per cent) seven public sector banks achieved the target as compared to 4 banks in the private sector.

Table 1.5

Frequency Distribution of lending of Indian Scheduled

Commercial Banks to Agriculture, Weaker Sections and

Priority Sector Advances as a Percentage to NBC

Agriculture as % NBC – 2004

<12%

12-15%

15-18%

>18

Total Banks

% NBC

Public sector Banks

3

6

9

9

27

% Share of Agriculture Credit

4.2

36.4

26.2

33.3

100

15.41

Private Sector Banks

15

3

1

11

30

% Share of Agriculture Credit

16.2

5.2

1.3

77.1

100

15.81

Weaker Sections as % NBC

<5%

5-7%

7-10%

>10

Total Banks

%NBC

Public sector Banks

8

7

5

7

27

% Share of Weaker Sections

9.6

16.9

41.4

30.1

100

7.44

Private Sector Banks

25

0

1

4

30

% Share of Weaker Sections

50.3

0

1401

35.6

100

1.34

Priority Sector Advances

<40%

40-44%

44-48%

>48

Total Banks

%NBC

Public Sector Banks

2

9

10

6

27

% Share of Priority Sector

22.3

24.5

29.2

24

100

43.94

Private Sector Banks

12

2

2

14

30

% Share of Priority Sector

10.7

8.8

8.3

72.1

100

47.35

Source: Statistical Tables Relating to Banks in India

[1]. M.Narasimhan, “Working Group on Rural Banks”, RBI, Mumbai, pp 117-118     



Source by S.Ganesan

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