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A Comparative Study of Priority Sector

Lending in India by Public and Private Sector Banks

Yogesh Gupta & Sanjeev Kumar

Commercial banking has played a very important role in the economic development of all the nations of
the world. The commercial banking system in India consists of public sector scheduled banks and private
sector scheduled as well as non-scheduled banks. On July 19, 1969 fourteen commercial banks with
deposits worth Rs. 50 crores or more were nationalized. This was a historic event in the banking
structure of the country. In 1980, six more commercial banks with deposits worth Rs. 200 crores were
nationalized. At present their total number is nineteen sine, in 1993, New Bank of india was merged
with Punjab National Bank. In terms of business the public sector banks now have a dominant position.
The nineteen nationalized banks had 33,211 offices all over the country on June 30, 2004. In terms of
branches and business done by the private sector banks are much smaller than nationalized banks. In
2004, private sector banks has a network of 5,794 branches operating in the country. Priority Sector
Lending

In section I st overall priority sector lending from the year 1997 to the year 2005 is analyzed.

In section 2nd, structure of priority sector lending from the year 1997 to the year 2005 is
analyzed.

And in the last section 3rd, overall incidence of Non-Performing Assets in priority sector and
sector-wise Non-Performing Assets of public sector banks and private sector banks from the year
2000 to the year 2005 is analyzed.

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 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
PSU Banks FY04 FY05
Allahabad Bank 45.4 45.9
Bank of Baroda 45.7 48.5
Canara Bank 43.1 43.9
Bank of India (BOI.BO, news) 47.9 51.3
Corporation Bank of38.1 41.7
Priority advances as % gross Disbursals towards small-scale sector, rural housing,
credit
OBC 42.3 45.1
educational loans and home loans (up to Rs 1.5 m) are
Source: RBI
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.

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
(CRSL.BO, news) 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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