Finance Minister Arun Jaitley has prodded public sector banks (PSBs) to lower lending rates, consequent to the RBI lowering the signalling rate of interest. The reluctance on the part of PSBs can be understood by analysing critical factors that influence their commercial viability. Some of these issues, such as rising non-performing assets (NPAs) and uncertainty in global and domestic markets, have been extensively discussed. But factors crucial to the debate, like priority sector lending, reserve ratios and the financial costs of the Jan Dhan Yojana, have been ignored.
The provision of priority sector lending can be traced to 1967 when, in view of two years of severe shortfall in agricultural output and slowdown of industrial production, the flow of credit to agriculture, exports and small-scale industry (SSI) was liberalised on a selective basis. Around the same time, the government had initiated steps to institute social control of banks and promote purposive distribution of credit, consistent with basic economic and social objectives. To rectify the persistent trend of extending loans exclusively to large industries and business houses, priority sector lending was devised. At a meeting of the National Credit Council in July 1968, it was emphasised that commercial banks should increase their credit to agriculture and SSI. The social control measures took effect from February1969, and bank lending was considerably reoriented with the nationalisation of major commercial banks in July 1969. By November 1974, PSBs were advised that no less than one-third of aggregated advances were mandated for the priority sector.
The performance of the priority sector, with limits raised to 40 per cent of advances since 1985, has not been sterling, as reflected in rising NPAs. The low rate of interest for advances in the priority sector also impacts the performance of commercial banks. Also, specialised agencies have been instituted for those specific activities for which priority-sector lending was originally conceived — the Export Import Bank of India and the National Bank for Agriculture and Rural Development in 1982; the Small Industries Development Bank of India in 1990; and the Micro Units Development Refinance Agency in 2015. In view of this, priority-sector lending should perhaps be revised.
Initially, commercial banks were required to maintain reserve ratios to safeguard the interest of depositors. But since 1978, these are being used as instruments of credit control. The reserve requirements bring about a reduction in banks’ resources, affecting their ability to expand credit, and constraining the liquidity available for lending. Commercial banks have to maintain a minimum amount of stipulated liquid assets of their deposits, mainly in government securities. Originally, as per the Banking Regulation Act, the Statutory Liquidity Ratio (SLR) was 20 per cent. But since 1962, the prescribed ratio has been higher and ranged between 23 and 25 per cent. Investments in government securities earn a nominal rate of interest compared to credit extended to the private sector. The cash reserve ratio (CRR) has also been high and has ranged from 11 per cent in 1988 to 4 per cent since 2013. The balances maintained under CRR don’t earn interest. Although these reserve ratios were instituted for the protection of depositors and creditors, with the institution of the Deposit Insurance and Credit Guarantee Corporation, their relevance is restricted to credit control.
PSBs have spearheaded financial inclusion since the nationalisation of the State Bank of India in 1955. The presence of PSBs in rural areas is substantially higher than that of private banks. The role of PSBs in the attempt to extend financial inclusion to remote parts under the Jan Dhan Yojana has been exemplary. The share of private-sector banks in new accounts opened under the scheme is just 4 per cent. Of the 16 crore Jan Dhan accounts, nearly half are non-operational. The financial burden of maintaining and servicing such accounts is more on the PSBs.
Governance issues also restrict PSB performance. Positions of chairpersons of several PSBs are vacant. Further, the short period of chairmanship and absence of accountability reflect in PSB performance. So, the flexibility to revise interest rates for PSBs is restricted.
The writer is RBI chair professor in economics, IIM Bangalore. Views are personal