Inverting The Pyramid

Tag: Priority Sector Lending

  • Financial Reforms & MFIs

    Financial reforms that the government is trying to bring in are going to affect MFIs like all other financial institutions in some or the other way.  Among the major recommendations in the last report on financial reforms banking license to NBFCs & PSLCs are the ones which I think if implemented will affect MFIs most significantly. Banking license is still self explanatory, so I will try to find out what is this PSLC we are talking about.

    Priority Sector Lending Certificate..what is it??

    The idea was born in the abovementioned 2008 report of the Committee on financial sector reforms titled- ‘A Hundred Small Steps’ better known as the Raghuram G. Rajan committee report.  The committee came up with a very novel idea to help implement the priority sector lending mandate more efficiently. It suggests that all registered lenders be issued certificates for the amount they lend to the eligible priority sectors. Then a market would be opened up for such certificates, where the deficient banks can buy these certificates for the amount they are falling short by. However, the loan will remain on the books of the original lender and any default in the loan will affect the lender only and not the certificate holder. For those who know will find it much like the CERs or the carbon credits..Indeed it is, in many aspects.

    The million $ question..how will these certificates be priced?

    The price obviously will be less than the penalty faced by the banks in case they fail to achieve their target & sub targets. The actual price discovery will be done by the market.

    So why is it important for MFIs??

    At the heart of the proposal of PSLC lies the idea to make PSLC a market-driven interest subsidy to those who make priority sector loans. The income from selling these certificates is what will make lending more profitable for lenders. So now we can see how MFIs stand to benefit, especially the large MFIs will be the largest beneficiaries as these certificates will have some minimum size regulations, also only they can be of help to large banks who will be looking at some serious volumes of PSLC.

    The way I see it, if PSLC are introduced it will be the next big thing for major MFIs. We might see upsurge of many specialized institutions in priority sector lending which will try to thrive on this initiative. Whatever may be the consequence for the institutional participants, it will surely go a long way in benefitting the end customer, the borrower and will push us an inch closer to what we aspire to achieve- ‘financial inclusion’; cheers to that! 🙂

  • Banks & Priority Sector Lending

    As we know the commercial banks have to meet the RBI guidelines of 40% net advances of their Adjusted Net Bank Credit to the priority sectors. In case you are wondering what all sectors come under this ‘priority’ list they are- advances for agricultural sector, small & micro enterprises, retail trade, education, housing, Differential rate of interest scheme (there are various sub-targets apart from this overall 40% as well, but we won’t get into those details now). In case a bank fails to meet these targets they face penalty which is- Contribution by banks to Rural Infrastructure Development Fund (RIDF) or Funds with other Financial Institutions, as specified by the Reserve Bank. The term, interest and size of such deposits are dictated by the central bank from time to time. In logical conclusion the returns from such deposits are not favorable for the banks and so they try to avoid it, you will see banks going on PSL spree in the last quarter of the year trying to close down the gap.

     

    So the question is why do banks have to struggle to meet these targets & sub-targets, why don’t they lend enough to these sectors themselves??

    The Raghuram report on financial reforms identifies the reasons as-

    “Interest rate ceilings (either imposed by the centre or the state) make priority sector lending unprofitable, and ensure that the banker attempts to recover his money through hidden charges in the loans that are made, or that he does not lend so the poor are driven to the moneylender. The Committee believes a better way to proceed is to liberalize interest rates while increasing safeguards that prevent exploitation.”

    The committee goes further to recommend

    –          Liberalization of interest rates charged on these PSL to ensure that the credit reaches the poor.

    It also suggests having a system in place, to ensure-

    –          Lenders disclose the total cost being charged on such advances

    –          Periodic public disclosure of maximum and average interest rates charged by the lenders.

    –          Only loans that stay within a margin of local estimated costs of lending to the poor be eligible for PSLCs.