EAC-PM calls for changes in priority sector lending to enhance efficiency; greater flexibility to banks

Synopsis

An Economic Advisory Council to the Prime Minister paper has proposed shifting priority sector lending focus from economic efficiency to social equity, suggesting outdated categories be removed to give banks more flexibility.

A working paper by the Economic Advisory Council to the PM (EAC-PM) has proposed changes in the focus of priority sector advances (PSAs), saying they are economically less efficient when compared to public funds. This, it said, will give banks more flexibility in allocating capital.

Given the economic inefficiency, the focus of PSAs should be changed from economic to social equity and emphasis should be placed on its original goals of making credit available to small and marginal farmers, small scale industries and weaker sections, the paper said.

“Legacy inclusions in the definition of priority sector that are no longer relevant can be removed while targets can be adjusted commensurately,” it said, adding that with these changes, banks will have more flexibility in allocating capital while restoring emphasis on the social goals of PSAs.

The policy on priority sector lending has been in place in India for almost five decades under which banks are required to direct at least 40% of their overall credit towards the priority sector.

The priority sector encompasses a broad range of economic activities such as the provision of credit to small and marginal farmers, micro enterprises and weaker sections aiming to address systemic equity gaps.

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The overall credit disbursement to priority sectors including agriculture, MSME and social infrastructure by 85% over the six year period to Rs 42,73,161 crore in 2024 compared to Rs 23,01,567 crore in 2019.

Titled ‘Economic Impact Analysis of Priority Sector Lending’, the paper has been co-authored by S Mahendra Dev, chairman of EAC-PM, Sri Vatsa Sehrab and KK Tripathy who are joint directors at EAC-PM and Kamil KPS Bhullar who is the deputy director at EAC-PM.

The paper, which examines the status and distribution of priority sector lending in India using district level quarterly data obtained from the Reserve Bank of India for the period 2020-2025, further said that the distribution of priority sector credit in India is heavily skewed.

63 out of the 809 districts (7.8%) account for about 46% of overall PSAs. Among different types of PSAs, 92 districts (11.4%) account for about 67.3% of MSME credit, while 123 districts (15.2%) account for about 88.3% of medium enterprise credit, it said.

“Northeastern states, Himalayan states and Eastern parts of the country are particularly underserved,” it added.

The paper further said that priority sector lending certificates (PSLCs) provide flexibility to banks without significantly altering regional PSA distribution, terming them as effective and efficient indirect PSA instruments.

PSLCs, which were introduced by RBI in 2016, help mitigate bank profitability risks from PSAs by allowing banks to trade the fulfilment of priority sector obligations at a market determined rate without trading the underlying asset or risk.