In a significant policy update, the Reserve Bank of India (RBI) has eased Priority Sector Lending Norms for SFBs, marking a strategic shift aimed at improving lending flexibility for Small Finance Banks (SFBs). The central bank has revised the mandatory target for priority sector lending (PSL) from 75% to 60% of the adjusted net bank credit (ANBC). This move is projected to unlock nearly ₹40,000 crore, providing these banks with much-needed room to diversify their loan portfolios and enhance profitability.
What Is Priority Sector Lending?
Priority Sector Lending is a mandate under which banks are required to allocate a portion of their total lending to sectors deemed essential for economic development. These sectors typically include:
- Agriculture
- Micro, Small, and Medium Enterprises (MSMEs)
- Education
- Affordable housing
- Renewable energy
- Social infrastructure
The main objective of PSL is to ensure that underserved and economically weaker sections of society get access to necessary credit facilities. SFBs, since their inception, have been key players in reaching unbanked and underbanked regions.
The Need for Regulatory Change in Priority Sector Lending Norms for SFBs
Under the previous PSL norms, SFBs were required to allocate 75% of their ANBC to priority sectors, a significantly higher mandate than traditional commercial banks. While this helped boost rural and inclusive banking, it also constrained SFBs from diversifying their portfolios. The heavy dependence on microfinance often resulted in higher credit risk and asset quality concerns.
With the easing of norms, SFBs are now required to direct only 60% of their ANBC to priority sectors. Additionally, 20% of ANBC can now be allocated to segments where SFBs hold a competitive advantage. These include:
- Loans against property
- Personal loans
- Vehicle loans
- Gold loans
- Loans to salaried individuals
How Will SFBs Benefit from Revised Priority Sector Lending Norms for SFBs?
The relaxation in PSL requirements offers multiple benefits for SFBs:
- Operational Flexibility: The reduced target allows banks to tailor their portfolios based on market demand and risk tolerance.
- Diversification: SFBs can now move beyond microfinance and explore retail lending products, which generally offer better margins.
- Improved Asset Quality: By reducing overexposure to high-risk segments, banks can better manage non-performing assets (NPAs).
- Increased Profitability: With more funds available for secured and low-risk lending, SFBs can enhance returns and operational stability.
This change may also attract Non-Banking Financial Companies (NBFCs) to apply for SFB licenses, seeing better long-term growth prospects.
Future Outlook: Strategic Shifts Ahead
Industry analysts believe that this reform will shape the strategic direction of SFBs over the next 2–3 years. While the immediate financial gains may be modest, the long-term impact could be significant. SFBs may increasingly enter the consumer loan market, introduce loan products for salaried classes, and extend credit in urban centres.
The move also complements RBI’s guidelines for the voluntary conversion of SFBs into universal banks. Currently, 11 SFBs operate in India, and three have already applied for this upgrade. The relaxed PSL norms align with this broader vision, giving SFBs the framework to grow and expand like full-fledged commercial banks.
Role of Priority Sector Lending Certificates (PSLCs)
Another benefit under the revised framework is the scope for earning through PSLCs. SFBs that exceed their PSL targets can sell these certificates to other banks falling short of their mandates. This opens a new revenue stream, especially in sectors such as small and marginal farmers and micro enterprises.
Conclusion
The Priority Sector Lending Norms for SFBs Eased by RBI marks a pivotal shift in India’s financial regulatory framework. By reducing the PSL target, the RBI has not only acknowledged the operational challenges of SFBs but has also paved the way for more dynamic and sustainable banking practices. This reform is expected to encourage innovation, improve credit distribution, and empower SFBs to play a broader role in the nation’s economic growth.
