Oct 21, 2005|
Banks: To favour 'priority' lending?
The surge in credit disbursements over the last couple of months has been one of the brighter facets of India's banking sector. Banks are no longer preoccupied with parking funds in government securities. They are eager to lend. This reflects as much the turnaround in the economy, as the improved balance sheets of the banks themselves.
But is the concentration of bank credit in the retail segment prudent enough? Neither the government nor the Reserve Bank of India (RBI) seems to think so. There is concern over the composition of credit as well as the price of credit. The RBI governor, Mr. Y. V. Reddy gave expression to the latter concern at the FICCI-IBA seminar. He quipped, "An area of concern, in terms of public perception, is that there is under-pricing of credit risk for private sector corporates while there could be overpricing of risks in lending to the priority sector."
Disbursals towards small-scale sector, rural housing, educational loans and home loans (up to Rs 1.5 m) are classified by banks under the category of "priority sector lending". As per RBI regulations, banks have been mandated to disburse atleast 40% of their total disbursals to the priority sectors, of which advances to agricultural sector should comprise at least 18%. Priority sector lending is a good option for banks to expand their business. PSU banks especially, given their compulsion to oblige to the statutory regulations and project a 'socially oriented' image, continue to outperform the private and foreign banks in this respect and have hiked their exposure to this segment. However, it is about time that their private sector counterparts also realize the true potential of priority sector lending.
Priority advances as % of gross credit
The point that has often been raised in recent times is that the banks view priority sector lending as means of subsidising the larger corporates. The prime-lending rate (PLR) is the risk-adjusted rate for the best corporates (AAA rated and the like). Yet, banks lend to the best corporates at sub-PLR rates. Banks usually compensate themselves by overcharging the priority sector. The rationale for this could be that they seek to earn a return on capital on the overall relationship with corporates. The return includes not just interest income but fee income as well. Besides, big corporates bring to banks large volumes of low-cost deposits that lower the cost of funds. As a result, banks can afford to price loans below the risk-adjusted rate where large corporates are concerned, for the other elements in the risk-return trade off ensure that the return on capital meets the hurdle rate for the bank.
Thus, there are several reasons due to which banks tend to shy away from priority sector lending:
Small businesses do not generate much fee income. Hence, they are expected to be charged the risk-adjusted rate for loans. At the same time the RBI disallows banks to charge rates above 14% to the priority sector.
The latter part of the 90's was a bad period for small businesses and many banks burnt their fingers with them. The business environment has since improved and small businesses that survived are poised to do well. Infact, the RBI data on net NPAs clearly shows that the priority sector lending has offered better asset quality to banks. But estimates of risk based on past data are bound to be biased upwards and hence banks peg the lending rates for SMEs on the higher side, which in turn is unviable for the smaller corporates.
Risk appraisal norms are not clearly defined for the priority sector. Especially, in cases where is paucity of well-recorded financial data, quantification of risk becomes difficult.
The RBI's report on overall priority sector lending is singularly uninspiring. Most private banks have failed to meet the target of 40% of bank credit as also the sub-target of 18% for agriculture. Even, within priority sector lending, housing loans enjoy a majority proportion because of their lower risk profile. The tenor of the report suggests that the group regards priority sector lending merely as a social obligation. This is an incorrect reading in today's context. While the larger corporates enjoy a better bargaining power, the less fortunate SMEs at times fail to garner the much-needed funds.
Banks therefore, need to correct the distorted image of priority sector lending and capitalise on the opportunity of harvesting on the higher yielding assets (as compared to AAA corporates), especially at a time when margins are under pressure. With rating agencies such as CRISIL now offering rating services for SMEs, risk appraisal for such ventures is also no longer a hurdle. Such action will not only help banks distribute their risks over a larger asset class but also position them at a competitive advantage with respect to foreign banks, the latter having very little penetration for priority sector lending. The rules of the game have thus changed and banks need to get their priorities right!
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