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Recasting priority sector lending

A full 15 years after the Committee on Financial Sector Reforms (Narasimham Committee-I) recommended phase-out of directed credit, an internal working group of the Reserve Bank of India (RBI) has clearly called for continuation of the concept of priority sector lending by banks. This major recommendation, made in the "draft technical paper" presented by the group, will be welcomed by small scale industries (SSIs) and stakeholders in the farm sector. The panel has cited in support of its conclusion the fact that agriculture continues to account for the largest segment of workforce, disproportionate to the sector's contribution to the gross domestic product, and the large contribution of SSIs to production, employment and exports. The report has also sought to undo, even if only partly, the dilution the priority lending sector concept has suffered over the past decade on account of the inclusion of a wide range of activities in the list of qualifying advances. Its recommendation to exclude advances to a range of institutions — from electricity boards and State-level corporations to educational institutions — from the eligibility list should, if implemented, force banks to focus once again on funding the farmer, the small entrepreneur and small non-manufacturing enterprises.

However, in opposing the introduction of a sub-target for lending to the SSI sector by domestic banks, the working group has gone against the RBI's declared policy of 2004 that priority sector lending should focus on direct advances. It is hard to imagine how banks will be motivated to finance the small entrepreneur if the performance in lending to the small industry sector is subsumed under the overall priority sector target. The benefit from pruning the list of eligible categories would be reaped by sections other than the small entrepreneur. The reason cited by the working group — that there has been a decennial growth (1995-2004) of 100 per cent in lending to the small sector — does not take into account the growth in the actual need, in terms of term loans and working capital. Another recommendation is the creation of a marketable instrument — the Inter-Bank Participation Certificate in Priority Sector Lending — which would encourage banks to share risks in lending to the targeted sections and which could be transferred from one bank to another. Generally, market mechanisms within a regulatory framework are considered a desirable alternative to inflexible micromanagement regimes. However, a deeper study of the proposed system might be necessary before one can say with confidence that it will fulfil its stated objective. The working group's suggestion to change the basis of determining the annual priority sector targets of banks from "net bank credit" to the previous year's disbursal might prompt banks to limit disbursals deliberately, as a pre-emptive strategy against higher targets in the succeeding year.

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