With Priority Sector Lending Quotas becoming fully applicable to Foreign Owned Banks (FOBs), agrarian lending should expect a substantial boost in the coming year. This may not necessarily be the case though, as FOBs have proven adept at delaying and avoiding regulation, often using loopholes to skirt them completely.
Last Thursday, Reserve Bank of India (RBI) issued a circular reaffirming that foreign owned banks (FOBs), having over 20 branches in India, meet sub-targets for loans to small and marginal farmers in priority sector lending. Set at 8% of Adjusted Net Bank Credit (ANBC), out of the 18% earmarked for the agrarian priority sector, the circular directs Standard Chartered Bank, Citibank and HSBC to start allocating a fifth of their priority sector loans to famers with landholdings less than 2 hectares, tenant farmers, share-croppers and landless agrarian labour.
FOBs, for the longest time, were allowed to comply with concessional rates of priority sector lending. Up to 2012-13, while all domestic commercial banks allocated 40% of ANBC to priority sectors, FOBs chipped in only 32%. FOBs were also exempt from sub-targets in priority sector lending. Such concessions led to several operational disparities between them and their domestic counterparts, public and private. To rectify these and create a level playing field, RBI in July 2013 mandated that FOBs with over 20 branches be treated on par with domestic commercial banks. To smoothen the transition, FOBs were given a period of 5 years to get their loan books in order.
FOBs would need to meet an agrarian lending target
With the grace period set to end this March, FOBs must now apportion 40% of their loans towards priority sectors. Of this 45% would go to agrarian priority sector with nearly half of that to be specially allocated for small and marginal farmers. What this means is that come the new financial year, agrarian priority sector lending in general and loans to small and marginal farmers in particular can ideally expect a sizeable credit boost. This may not necessarily be the case though, as FOBs have proven adept at delaying and avoiding regulation, often using loopholes to skirt them completely.
Standard Chartered, Citibank and HSBC dominate the FOB section of Indian banking cornering over 50% of all FOB advances made in 2016-17. However, their record in priority sector lending remains, like other FOBs, quite shabby. Priority sector lending quotas, as mentioned before, are computed on the basis of ANBC which roughly amounts to all loans given by the bank. Add to this are investments made by the bank in stocks, bonds and other securities, excluding those mandated by government or RBI. As classifications of investments are only available in disaggregated forms, ANBC becomes a rather convoluted figure to determine. To avoid getting mired in computing ANBCs on a bank to bank basis, a simpler parameter can be used instead; priority sector lending as a share of total advances as declared by audited financial statements of banks. This may not give accurate figures as to the quantum of shortfall, but comparative analysis with domestic competitors will help provide ball-park estimates of what FOBs must plough into priority sectors to meet domestic norms.
As per RBI data for the year ended 31st March, 2017, FOBs at an average allocate less than 29% of total advances to the priority sector, lagging significantly behind public sector banks at 37% and even domestic private banks at 31%. The performance of Standard Chartered Bank, Citibank and HSBC together at 28.5% is marginally worse than that of all FOBs, implying that there is significant ground for these three to make up. To put it as a number, for these three FOBs to conduct priority sector lending at par with the rest of the industry (public and domestic private), they should have increased their allocation in 2016-17 by over Rs. 1.12 lakh crores.
Bleak as that may be for these three banks, meeting the agrarian quota within priority sector lending could potentially be even more problematic. Standard Chartered Bank’s 2016-17 balance sheet states that out of the total priority sector lending, the amount lent to the agrarian priority sector stands at a piffling 2%. Citibank (for 2015-16) and HSBC perform a bit better at nearly 16% each, but still remain miles off from the mandated 45%. How would these three FOBs, with average agrarian priority sector lending barely crossing 9% of total priority sector lending (as of 2015-16), make good a shortfall which is almost four times the amount they’ve already lent?
Less than 3% FOBs in rural areas
FOBs have often cited lack of knowledge of domestic rural markets to explain their pathetic performance in agrarian lending. For some FOBs that are relatively new entrants in Indian banking, this may be the case but not for the eligible three. Standard Chartered Bank opened its first Indian branch in 1858, HSBC effectively in 1853 while Citibank has been operating in India for nearly 120 years. The real reason behind the agrarian lending paralysis lies in the distribution of FOB branches. Nearly 75% of FOB branches are concentrated in metropolitan centers with less than 3% confined to rural areas. With such skewed figures, it is no wonder that Standard Chartered Bank, Citibank and HSBC find it difficult to meet general agrarian quotas, let alone the small and marginal farmer sub-target.
The situation is also not one that is witnessing any improvement either. FOBs are in fact winding down their branch presence in the country, possibly to avoid meeting RBI guidelines, and shifting to branchless banking. In 2016-17 for example, the number of FOB branches in India shrunk by almost 10%. With neither the infrastructure to reach out to the rural populace nor does it seem the will, FOBs often resort to purchasing Priority Sector Lending Certificates (PSLCs) to make good their ever mounting shortfall.
PSLCs are instruments that allow for transfer of credit for lending to priority sectors. The credits can then be submitted to RBI to meet quotas. FOBs use them to acquire priority sector loans from micro-finance institutions, public sector banks and NBFCs to bolster their urban-industrial/services skewed loan books and present some degree of adherence to RBI norms.
Multiple consequences on Indian banking
The proliferation of PSLCs has multiple consequences on Indian banking. Primarily, these stem from the nature of the instrument which only transfers the fulfillment of priority sector lending obligation but not the actual loan. This leaves actual lenders with the burden of maintaining a low-value high-volume loan book (full of unsecured debt) along with the poor rate of return and high transaction costs (including maintenance of rural infrastructure along with the requisite staff) it entails. FOBs on the other hand can continue to target highly securitized and remunerative borrowers, maintaining their profitability while avoiding investments in the rural sector and other societal obligations.
In essence, PSLCs allow FOBs to buy their way out of RBI regulations and cater only to the financial cream of the Indian populace, shirking developmental goals that businesses in the third-world should ideally adhere to, or in this case legally. This defeats RBI’s attempts link rural expansion as a pre-condition for more urban presence as well as diluting the agenda behind the promotion of priority sector lending. The government too has caught wind of the rampant PSLCs trade but instead of clamping down on FOBs, it instead chose to levy GST at 18% on the transactions.
RBI has done a commendable job in bringing FOBs within the full purview of priority sector lending. Not only to create a level playing field between domestic and foreign owned banking entities but also to reinforce societal and developmental goals as an intrinsic part of the cost of doing business in India. It has given FOBs ample time to synchronize with domestic norms and even provided leeway to smaller FOBs, though these are identified by rather archaic categories based on number of branches. FOBs in turn have responded by lobbying hard to delay and deflect regulation often even threatening to close Indian operations. These threats must be ignored. FOBs have a negligible presence in Indian banking, even less so in sectors that desperately need banking services and hence there is little reason to subsidize their presence in the Indian market, especially when there is little they offer that is not already catered to by domestic counterparts.
RBI must, in the coming year, stringently monitor these banks to ensure that they meet quotas. It must compel FOBs to expand their rural presence, through brick and mortar branches and negate their abuse of PSLCs. These instruments should be abolished, or at least reformed in such a manner that would limit their usage and ensure that risk is transferred alongside credit. This might even lead to a better spread of NPAs among banks. Priority sector lending obligations should ideally be made cumulative and non-transferrable with lapses penalized and surpluses rewarded. If not, setting new quotas will result in only jugglery between banks and not in any actual expansion of credit to farmers; small, marginal or otherwise.