Innovation in priority sector lending

Abee-keeping farmer can be given Rs.2 crore in loans but a paddy farmer can only get Rs.50 lakh. For buying a home in a town with a population of more than a million, exactly Rs.28 lakh as a home loan is allowed but only if the overall cost of the house is less than Rs.35 lakh Rs.10 lakh in an education loan or the same amount to install a solar panel in a home will also qualify.

Bankers in India have to contend with 20 pages of such rules and restrictions on a daily basis. These form the basis for ''priority sector lending'', or PSL, norms laid out by the Reserve Bank of India (RBI) as a diktat for all banks in the country. Directed lending through a PSL framework has been in existence since the 1970s in India. All banks in India have to lend up to 40% of their total loan book in eight defined priority sector categories with a quota for each category and subcategory. Interest rates for loans to these sectors are as per RBI?s directives.

Thankfully for bankers, all this is about to change. RBI issued a notification on 7 April permitting the issue and trading of PSL certificates. This means that bank A which has a comparative advantage in, say, bee-farming loans and is required to lend, say,Rs.50 crore as per its PSL guidelines, can now lend Rs.100 crore to bee farmers. It can then sell the extra Rs.50 crore as PSL certificates to banks B and C that have to meet their quota of such loans but don't have the skills to do so.

More importantly, banks B and C will not be responsible for a sudden downturn in honey demand in the country that will impact the recovery of these loans. That is entirely bank A's responsibility. In effect, the larger social objective of loans to priority sectors and weaker sections of society will be met without burdening each bank with the specific responsibility of doing so. There is a certain laudable, Ricardian elegance to this initiative of the central bank.