PARICHAYA - A SOCIAL NETWORKING MODEL
B/T6/08
Table of ContentS
Page No
1. Executive summary 3
2. Priority sector lending 4
3. Target to bank for priority sector lending 6
4. Segment-wise priority sector lending 85. Determinants of
bottom line of bank and PSL 10
Interest spread of priority sector loan
Non performing assets in priority sector lending
6. Impact of interest subsidy on profitability 13
7. Inference 15
8. In a nutshell 16
9. Exhibits 17
10. Bibliography 22
1. EXECUTIVE SUMMERYThe composition of Indian banking sector
always keep changing. However, the nationalisation of banks in 1969
completely transformed the structure of commercial banks. The
primary motive behind nationalisation of banks was the inclusion of
weaker and hitherto neglected segments of society in the purview of
banking. Nationalization of banks may have led to weakening of
credit norms; but that single act did much to encourage financial
savings among ordinary people and to make bank credit available to
backward sectors of the society and economy. The branch expansion
policy and revamped lending policy paved the way for neglected
segments to reach the door of banks.
The origin of priority sector prescriptions for banks in India
can be traced to the Credit Policy for the year 1967-68, wherein it
was emphasized that commercial banks should increase their
involvement in the financing of priority sectors, viz.,
agriculture, exports and small-scale industries, as a matter of
urgency. However, the description of the priority sector was
formalized in 1972 on the basis of the report submitted by the
Informal Study Group on Statistics relating to advances to the
Priority Sectors constituted by Reserve Bank in 1971.
Indias banking system was, until 1991, an integral part of the
government is spending policies. Through the directed credit rules
and the statutory pre-emptions it was a captive source of funds for
the fiscal deficit and key industries. Through the CRR and the SLR,
more than 50% of savings had either to be deposited with the RBI or
used to buy government securities. Of the remaining savings, 40%
had to be directed to priority sectors that were defined by the
government. Besides these restrictions on the use of funds, the
government had also control over the price of the funds, i.e. the
interest rates on savings and loans
The opening and liberalisation of economy led to competition in
banking sector, so far largely dominated by public sector banks and
particularly State bank of India. Increased competition impacted
the bottom-line of the banks negatively. In recent times bank
authorities are seriously concerned about decreasing margin and
declining profitability. A large number of researchers and
economists blame the various credit and developmental policies of
the Government of India and Reserve bank of India (RBI), and argue
that the increased quantum of interest subsidized loans causing
heavy interest income losses. These policies also caused higher
establishment expenditure to supervise small accounts without
matching productivity; raised the level of credit outstanding of
sick units; resulted in the poor recovery of small loans; and
expanded the volume of non-performing assets, etc., in turn have
plunged the profits and profitability of public sector banks.
2. Priority sector lending
Before entering into nitty-gritty of these policies and
analyzing the impact on profitability, we must talk about the
components of Priority sector lending. As per RBI directives on
priority sector lending the following sectors and loans constitute
the priority sector lending:
1. Agriculture: Direct and indirect finance, no limit for
farmers but upto Rs.20 lakh for such as corporate, partnership
firms and institutions (Agriculture/allied activities).
2. Small scale industries: Direct finance to small scale
industries (SSI), includes all loans given to SSI units which are
engaged in manufacture, processing or preservation of goods and
whose investment in plant and machinery (original cost) excluding
land and building does not exceed the amounts specified in Section
I, appended.
3. Small road and water transport operators owning upto 10
vehicles. 4. Small business/ service enterprises shall include
small business, retail trade, professional & self employed
persons, small road & water transport operators and other
service enterprises (Original cost of equipment used for business
not to exceed Rs 20 lakh).
5. Retail trade shall include retail traders/private retail
traders dealing in essential commodities (fair price shops), and
consumer co-operative stores.
6. Micro Credit shall include provision of credit and other
financial services and products of very small amounts not exceeding
Rs.50,000 per borrower, either directly or indirectly through a
SHG/JLG mechanism or to NBFC/MFI for on-lending up to Rs.50,000 per
borrower.
7. Professional and self-employed persons (borrowing limit not
exceeding Rs.10 lakh of which not more than Rs.2 lakh for working
capital.8. State sponsored organizations for Scheduled
Castes/Scheduled Tribes.
9. Education Loan up to Rs.10 lakh for studies in India and
Rs.20 lakh for studies abroad (to individuals).
10. Housing Loan loans up to Rs.20 lakh to individuals for
purchase/construction of one dwelling unit per family and loans
given for repairs to the damaged dwelling units of families up to
Rs.1 lakh in rural and semi-urban areas and up to Rs.2 lakh in
urban and metropolitan areas.
11. Consumption loans under the consumption credit scheme for
weaker sections.12. Micro-credit provided by banks either directly
or through any intermediary; Loans to self help groups(SHGs) / Non
Governmental Organizations (NGOs) for on lending to SHGs
13. Loans to the software industry (having credit limit not
exceeding Rs 1 crore from the banking system)
14. Loans to specified industries in the food and
agro-processing sector having investment in plant and machinery up
to Rs 5 crore.
15. Investment by banks in venture capital (venture capital
funds/ companies registered with SEBI)
3. TARGETS TO BANKS FOR PRIORITY SECToR LENDING
All these components of priority sector can be roughly grouped
into Agriculture, SSI, housing, weaker sector and others. Beside
individual definition and limit given, RBI also set targets and
sub-targets under priority sector lending different types of
lenders as summarized below:
Domestic commercial banks
Foreign banks
Total Priority sector Advances40 per cent of Adjusted Net Bank
Credit (ANBC) or credit equivalent amount of Off-Balance Sheet
Exposure, whichever is higher.
advances
32 percent of ANBC or credit equivalent amount of Off-Balance
Sheet, Exposure, whichever is higher.
Total agricultural advances18 per cent of ANBC or credit
equivalent amount of Off-Balance Sheet Exposure, whichever is
higher.No Target
SSI advancesAdvances to SSI sector will be reckoned in computing
performance under the overall priority sector target of 40 per cent
of ANBC or credit equivalent amount of Off-Balance Sheet Exposure,
whichever is higher.
10 per cent of NBC or credit equivalent amount of Off-Balance
Sheet Exposure, whichever is higher.
Micro enterprises within SSI(i) 40 per cent of total SSI
advances should go to units having investment in plant and
machinery up to Rs 5 lakh,
(ii) 20 per cent of total SSI advances should go to units with
investment in plant & machinery between Rs 5 lakh and Rs. 25
lakh (Thus, 60 per cent of SSI advances should go to the micro
enterprises).Same as for domestic banks.
Export creditExport credit is not a part of priority sector for
domestic commercial banks.
12percent of ANBC or credit equivalent amount of Off-Balance
Sheet Exposure, whichever is higher.
Advances to weaker section10 per cent of ANBC or credit
equivalent amount of Off-Balance Sheet Exposure, whichever is
higher.No target.
Differential rate of Interest scheme
(DRI)Per cent of total advances outstanding as at the end of the
previous year. It should be ensured that not less than 40 per cent
of the total advances granted under DRI scheme go to scheduled
caste/scheduled tribes. At least two third of DRI advances should
be granted through rural and semi-urban branches. Granted through
rural and semi-urban branches.No target.
PENALITY PROVISIONS
Incase of default in meeting the above set targets, RBI impose
penalties for non-achievement of priority sector targets. Foreign
banks have to maintain deposit, equivalent to the amount of
shortfall in priority sector lending, with SIDBI. Public and
private sector banks are required to deposit amounts in the RIDF
(NABARD) linked to their shortage under achievement of priority
sector lending prescriptions. There are no penalty provisions for
Regional Rural Banks. The interest rates on these deposits are
fixed by RBI.
4. segment-wise pRIORITY SECTOR LENDING OF BANKS for the period
1995 to 2004: (Exhibit-1 and 2)
The credit advanced to the priority sector by scheduled
commercial banks recorded an average annual growth rate of 18.4 per
cent during the period from 1995 to 2004, which was marginally
higher than the average annual growth of 18.0 per cent observed in
aggregate bank credit. However, the share of priority sector
advances as a percentage of NBC had shown undulating trends during
the period. During 1995-1996, it fell from 33.7 per cent to 32.8
per cent, but remained steady at around 35 per cent during the
years 1997 to 2000. Thereafter, it dipped sharply to 31.0 per cent
in 2001 recovered to 35.1 per cent in 2003 and further to 36.8 per
cent in 2004.
A. CREDIT TO AGRICULTURE
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.
Outstanding 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.
B. CREDIT TO SSI & SMALL ROAD/WATER TRANSPORT
OPERATORSScheduled commercial banks credit to SSI increased at an
average annual rate of 11.7 per cent during the period 1995 to
2004, as compared to the average annual growth rate of 18.4 per
cent in bank credit to priority sector during the same period.
However, the credit to SSI as a percentage of NBC declined from
13.8 per cent to 8.2 per cent
The average annual growth rate of advances to Road and Water
Transport Operators was at 12.7 per cent during 1995-2004. Loans to
Road and Water Transport Operators as a percentage of NBC declined
marginally from 1.4 per cent to 1.0 per cent.
C. CR DIT TO WEAKER SECTIONAs 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 percent in 2004, had fallen
short of the target considerably.
D. ADVANCES UNDER DIFFERENTIAL RATE OF INTEREST (DRI) SCHEME
The scheduled commercial banks are required to extend advances
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 March of previous year has
been fixed under the 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 has also declined over the years.
However, the amount outstanding increased marginally in 2004.
5. DETERMINANTS OF BOTTOM LINE OF BANKS & psl
The reforms in banking sector have not only brought healthy
competition in sector but also put the profitability under
pressure. However, the banks are now facing a number of challenges
such as frequent changes in technology required for modern banking,
stringent prudential norms, increasing competition, worrying level
of NPAs, rising customer expectations , increasing pressure on
profitability , assets -liability management, liquidity and credit
risk management, rising operating expenditure, shrinking size of
spread and so on. RBIs efforts to adopt international banking
standards have further forced the banks to shift the focus to
profitability for survival. The profitability of banks is function
of different variables. The income of the bank can be written as
linear equation as follows:
Y= a+b1X1+b2X2+b3X3+b4X4+b5X5+b6X6+b7X7+b8X8+
Where
Y= Net Profit (Profit after Tax), a= constant term,
b1 to b8 = Coefficients,
X1 = Interest Spread, X2 = Non-Interest Income (NII), X3 =
Credit/Deposit Ratio (C/D),
X4 = NPA as percentage to Net advances NPA), X5 = Provision and
Contingencies, X6 = Operating Expenses (OE), X7 = Business Per
Employee (BPE), X8 = Profit Per Employee (PPE), = Error Term.
However, we consider the variables, interest spread and
non-performing asset (NPA), as major factors which affect the
profitability of banks to a maximum extent. We hereby, will
consider these two factors as the parameters for measurement and
evaluation of effect of priority sector advances on banks
bottom-line.
INTEREST SPREAD (Net interest margin) OF PRIORITY SECTOR
LOANS
The net interest margin (Spread) is being the difference between
the interest income on loans & advances and the interest
expended on deposits. Higher the spread, better the profitability
bank will show. However, the interest spread has continually been
shrinking for most banks groups in India, as yields on assets have
declined more than proportionately the cost of liabilities. This
effect is even worse in case of the priority sector lending. Due to
government rules and regulations, the public sector banks has to
give 40% to PSL, the returns of the priority sector credit is
relative low as compared to non-priority sector lending.
Traditionally interest income has been main contributor towards
profitability of banks although presently share of non-interest
income in total income has been growing at rapid pace.
P Ganesan, in his article in {Journal of Financial Management
& Analysis, 2003} used the formula developed by Bishnoi T R
(1991) for calculation of mean interest rate. As per his
calculation, the mean interest rate in priority sectors for the
period 1995 to 1999 as shown in Exhibit-3.
The Exhibit-3 presents the computed average lending rates
charged by the Public sector Banks for priority sector and large
and medium-scale industries for the period between1995 to 1999. The
changes made by the Reserve Bank of India in the general lending
rates affected the average lending rates and the average lending
rate varied across different activities. There is not much
difference between interest between agricultural loans and other
priority sector loans. Even difference between various priority
sector advances and other sector is not significant, contrary to
common belief.
NON PERFORMING ASSETS (NPAs) IN PRIORITY SECTOR ADVANCESNon
Performing Asset means an asset or account of borrower, which has
been classified by a bank or financial institution as sub-standard,
doubtful or loss asset, in accordance with the directions or
guidelines relating to asset classification issued by RBI.With a
view to moving towards international best practices and to ensure
greater transparency, it has been decided to adopt the '90 days
overdue' norm for identification of NPAs, form the year ending
March 31, 2004. Accordingly, with effect form March 31, 2004, a
non-performing asset (NPA) shell be a loan or an advance where;
interest and /or installment of principal remain overdue for a
period of more than 90 days in respect of a Term Loan or
interest and/ or installment of principal remains overdue for
two harvest seasons but for a period not exceeding two half years
in the case of an advance granted for agricultural purpose, and
any amount to be received remains overdue for a period of more
than 90 days in respect of other accounts.The aggregate NPAs of
public sector banks under priority sector was maximum at Rs.25,150
crore in 2002, accounting for 46.2 per cent of total NPAs. However,
in 2004, it declined to Rs.23,841 crore, though as a percentage to
total NPAs, it increased to 47.5 per cent. The share of NPAs under
priority sector remained in the range between 44.2 per cent (2001)
and 52.5 per cent (1995) of the total NPAs for State Bank of India
and its Associates (Annexure 10). The details of NPAs of public
sector banks (including SBI and its associate banks) in priority
and nonpriority sector are presented in exhibit-5.
During last 5-6 years, Indian commercial banks witnessed robust
growth of around 30% in bank credit. The exhibit also shows that
during these years, share of priority sector lending increased from
31 5 in 2001-02 to 36.8% in 2004-05. This trend indicates that
banks lending to priority sector increased in tandem with overall
credit growth. Other visible trend is decreasing percentage of
gross NPA to net bank credit with decreased from a high of 13.45 in
2001-02 to 6.8% in 2004-05 and NPA in priority sector also
decreased substantially.
6. IMPACT OF INTEREST SUBSIDY ON PROFITABILITYBecause of
concessional interest rate to priority sector advances the subsidy
rate also has increased over the years but the subsidy rate is
almost constant for last few years. From 1992-93, the subsidy rate
for agriculture showed a declining trend and reached 0.29 per cent
in 1999. However, reductions in the rates also noticed in export
finance and retail trade. Though the subsidy rates are seemed to be
moderate, since the volume of advances are high, the subsidization
exerted adversely heavy pressure on the profits and profitability
of the commercial banks through interest income losses.
(Exhibit-4) presents estimated interest income loss due to
priority sector credit outstanding
The data indicates the impact of interest income loss on banks'
profitability. During these five year period, the trend clearly
indicates that total interest income loss due to interest subsidy
continue to decrease and during year 1999, total interest loss
stand at a level of just Rs.108.24 crore which is just around 2% of
total net profit.
The distribution of credit to priority sector has been at the
average rate of lending at less than 15 per cent per annum. Though
the average lending was still comparatively lower than the
commercial lending rate, it was higher than the Prime Lending Rates
(PLRs) of Public Sector Banks, which were in the range of 11.75 -
13.00 per cent. The average lending rate charged on priority sector
advances varied across different activities. During pre-reform
periods as a result of concessional lending on these sectors, the
subsidy rate also increased over the years, whereas, in post-reform
periods on account of monetary measures announced by RBI there was
steep reduction in subsidy rates.
The data published in Journal in financial management and
analysis (2003) shows that, during post-reform periods, the income
loss ratios were substantially lower than the profitability ratios
in all the years and the differences between them increased. The
higher interest income loss ratios significantly affected the
profitability ratios. Consequent to the introduction of
liberalization measures and reforms in financial sector, the banks
began to step-down the target for priority sector credit and thus
there was decline in the income loss ratios, which subsequently
increased the profitability ratios.INTEREST RATE LIBERALISATION
Prior to the reforms, interest rates were a tool of
cross-subsidization between different sectors of the economy and
banks were adversely affected by these types of policies.
However post reform era marked by series of events like
increased competition, deregulation of interest rates etc. The
deregulation of interest rates was a major component of the banking
sector reforms that aimed at promoting financial savings and growth
of the organized financial system. The deregulation of interest
rate given freedom to banks for fixing interest rate for loans and
deposits except few areas like Savings bank deposit rate, loans
under DRI scheme and loans to weaker section. This autonomy brought
down the impact of interest subsidy and resulted in much improved
profitability ratio.
Besides the high level of statutory pre-emptions, the priority
sector advances were identified as one of the major reasons for the
below average profitability of Indian banks during liberalization
period. The Narasimham Committee therefore recommended a reduction
from 40% to 10%. However, this recommendation has not been
implemented and the targets of 40% of net bank credit for domestic
banks and 32% for foreign banks have remained the same. While the
nominal targets have remained unchanged, the effective burden of
priority sector advances has been reduced by expanding the
definition of priority sector lending to include sectors like
information technologies etc.
Advances to weaker section and under Differential Rate of
Interest (DRI) Scheme, have average NPA level of aprox. 20% which
is much higher compare to priority sector average NPA level of 13%
for the period 2002 to 2004. But the percentage of total
outstanding to these sectors is just about 2% of net bank credit.
7.INFERENCE
After analyzing the trends and policies of Government of India,
Reserve bank of India and the scheduled commercial banks regarding
the priority sector lending (PSL) since emergence of concept of
priority, we have no doubt that PSL affects the profitability of
banks. The negative impact on profitability was more during pre
reform period.
Obviously, during post-reform periods, the income loss ratios
were substantially lower than the profitability ratios in all the
years and the differences between them increased. The higher
interest income loss ratios significantly affected the
profitability ratios. Consequent to the introduction of
liberalization measures and reforms in financial sector, the banks
began to step-down the target for priority sector credit and thus
there was decline in the income loss ratios, which subsequently
increased the profitability ratios.
It is also evident that pumping credit to priority sector at
subsidized rate of interest have had a negative impact on the
profits and profitability of Public sector Banks during pre and
post- reform periods. Mere reduction in target and sub-target of
priority sector credit outstanding or raising of interest rates is
not the only way to achieve the profitability. There is need to
review the concept of sub-sectors of priority sector, strong and
immediate policy consideration on recovery of overdue without
political intervention, productivity of bank employees for
effective recycling of funds and thereby Public Sector Banks would
be viable not only in the short run but also in the long run under
the reform process.8.IN A NUTSHELL
The level of gross NPA has fallen from a level of 17% in 1997 to
approximately 4% in 2006 which a remarkable achievement. Current
level of NPA is really comfortable considering international
standards and that too without curtailing the priority sector
lending. All these facts about NPA and subsidised interest rate
indicate that now banks are more open to disbursal of loans under
priority sector and now priority sector lending is not a taboo for
banks. Also during recent years various steps taken by government
as well as banks decreased level of default in loan payments. Other
major reason could be broadening the spectrum of priority sector
lending. Now some components of priority sector like export credit,
housing loan, education loan and loans to SSI & professionals
& self employed find special attention form commercial banks
and these banks are really competing to finance these sectors. In
last 3-4 years, housing finance became one of the most attractive
portfolios, primarily due to rise of Indian middle class and
secured nature. After witnessing slow growth in urban and metro
market, commercial banks (particularly private banks) are
aggressively diversifying their business in Semi-urban and rural
areas. Now small and medium enterprises (SME) already become one of
the most sought sectors for banks. The rejuvenated agriculture
sector also started attracting financial institutions for
agriculture finance. Microfinance through SHGs is one of the few
untapped sector in which percentage of default is very low but
potential for growth is huge. At present, percentage of C&I
advances (commercial and institutional-corporate) is almost
stagnant as these corporate directly raise funds from primary and
secondary market.
Therefore, except few laggard sectors in priority sector lending
such as Government sponsored schemes, loans to weaker section etc,
remaining sectors become most after sought portfolios for banks.
The commercial banks are not financing these sectors (constituent
of priority sector) due to some compulsion or obligation but for
the reason being the huge potential for growth in these
sectors.
All above facts and figures prove that the priority sector is
now attracting the commercial banks as financer for the sheer
reason of huge untapped potential and not merely due to compulsion.
No doubt, that the priority sector is not as profitable as the C
& I segment and other non-priority sector but definitely this
sector is generating revenue and no longer denting profitability of
banks. So in the era of deregulated interest rate and lesser
restriction for commercial banks, assumption that the priority
sector lending always dents the bottom-line of banks become invalid
in recent years.
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9.APPENDIXExhibit-1Segment200420052006
Gross Bank Credit7,64,38310,40,90914,45,837
1. Agriculture and Allied Activities90,5411,25,2501,72,292
(12.4)-12.5-12.3
2. Industry (Small, Medium and
Large)3,13,0654,26,8925,49,057
(43.0)-42.7-39.1
3. Services30,58448,137
-(3.1)(3.4)
4. Personal Loans2,45,0803,53,777
-(24.5)(25.2)
5. Trade24,86757,94881,402
-3.4(5.8)(5.8)
6. Others2,99,9491,14,0342,00,481
(41.2)(11.4)(14.3)
Memo:
7. Priority Sector2,63,8343,81,4765,09,910
(36.2)(38.2)(36.3)
7.1 Agriculture and Allied Activities90,5411,25,2501,72,292
(12.4)(12.5)(12.3)
7.2 SSI65,85574,58890,239
(9.0)(7.5)(6.4)
7.3 HousingN.A.90,8481,33,360
-(9.1)(9.5)
Exhibit-2
Exhibit-3
YearAgricul-tureSSISmall Transport operatorsRetail trade &
small businessProfess-ional LoansLarge & Medium scale
industryOthers
199515.4116.6616.3616.6016.3716.5116.08
199615.8516.8216.8416.7816.8117.6116.96
199715.8617.1817.0016.7715.9617.4016.77
199815.3716.7416.4416.4416.8016.7516.23
199915.2615.8516.1616.5816.3315.5515.61
Exhibit-4
YearAgricultureSSISmall Transport operatorsRetail trade &
small businessProfess-
ional LoansOthersTotal
1995257.77115.533.870.002.335.97385.41
1996463.32235.6521.8458.7615.2712.57807.42
1997465.0069.3012.8153.0729.5020.25648.32
1998459.1069.3012.5829.650.000.00527.58
1999108.240.000.000.000.000.00108.24
Exhibit-5
YearTotal Bank creditPriority sector amount out- standingShare
of PS to bank creditGross NPANPA % to Total Bank CreditPSL NPA to
Total PSL lendingNon PSL NPA %Net Profit
200252927118225531.07090113.417.511.211573
200360905320560634.86871511.315.09.417071
200474643225464835.1628928.411.17.022819
200586559431860936.8591576.88.45.921023
10.BIBLIOGRAPHY
www.rbi.org.inwww.iba.org.inwww.indiastat.comwww.blonnet.comwww.financialexpress.com/www.thehindubusinessline.com/www.domain-b.com/www.banknetindia.comwww.blonnet.comwww.ficci.comJournal
of services research article (Vol 6, No.2) by Bodla and Verma
Journal of Financial Management & Analysis. Mumbai: Jul-Dec
2003. Vol. 16, Iss. 2 by P Ganesan.Proquest data sourcesRBI paper
on priority sector lending
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