A Project Report On,

“A STUDY OF PUBLIC SECTOR LENDING BY BANKS.”

A Project Submitted to
University of Mumbai for partial completion of the
degree of Master in Commerce

Under the Faculty of Commerce

By

Name of the Student

SHAMA SHAHJAN SHAIKH

Prof. Sumaiya Farooque Ansari

Mangaon Shikshan Prasarak Mandal’s

G. Tatkare Mahavidyalay, Mangaon-Raigad

At Old Mangaon Near District Court
Tal - Mangaon, Dist.- Raigad. 402104
MAY-2023
 CERTIFICATE

This is to certify that SHAMA SHAHJAN SHAIKH has

worked and duly completed her Project Work for the degree of Master
in Commerce under the Faculty of Commerce in the subject of
Commerce and her project is entitled, “A STUDY OF PUBLIC SECTOR
LENDING BY BANK.” under my supervision. I further certify that the

entire work has been done by the learner under my guidance and that
no part of it has been submitted previously for any Degree or Diploma
of any University.

It is her own work and facts reported by her personal findings and
investigations.

Name and Signature

Prof. Sumaiya Ansari

Date of submission:
 DECLARATION BY LEARNER

I the undersigned SHAMA SHAHJAN SHAIKH here by

declared that the work embodied in this project work titled “A STUDY
OF PUBLIC SECTOR LENDING BY BANKS .’’ Forms my own
contribution to the research work carried out under the guidance of
prof. Sumaiya Ansari is result on my own research work and has not
been previously submitted to any other university for any other degree
to this or any other university.
Wherever reference has been made to previous work others at
has been clearly indicated as such and included in the bibliography.

I, here by further declared that all information on this document has

been obtained and other presented in accordance with academic rules and
ethical conduct.

Name and Signature

SHAMA SHAHJAN
SHAIKH

Certified by

Prof. Sumaiya Ansari

 Acknowledgment

To list who all have helped me is difficult because they are so numerous
and the depth is so enormous.

I would like to acknowledge the following as being idealistic channels

and fresh dimensions in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving

me chance to do this project.

I would like to thank my Principal, Dr. B.M.Khamkar for providing the

necessaryfacilities required for completion of this project.

I take this opportunity to thank our Coordinator Prof. Swapnil

Sakpal, for her moral support and guidance.

I would also like to express my sincere gratitude towards my

project guide Prof. Sumaiya Ansari whose guidance and care made the
project successful.

I would like to thank my College Library, for having provided various

reference books and magazines related to my project.

Lastly, I would like to thank each and every person who directly or
indirectly helped me in the completion of the project especially my
Parents and Peers who supported me throughout my project.
 INDEX

Sr.No. Contents Page No

1 Chapter 1- Introduction 6

2 Chapter 2- RESEARCH METHODOLOGY 25

3 Chapter 3- LITERATURE REVIEW 31

4 Chapter 4- Data Analysis, Interpretation and 39

Presentation

5 Chapter 5- CONCLUSION AND SUGGESTION 98

6 Bibliography / References 101

 CHAPTER-1

INTRODUCTION

The Reserve Bank of India decides to allot funds to predetermined public sectors of
the economy that may require credit and financial assistance, especially in cases where the
lack of PSL will lead to the heavy losses to the participants of that sector in some cases.
Public Sectors Lending is the role exercised by the RBI to banks, imploring them to
dedicate funds for specific sectors of the economy like agriculture and allied activities,
education and housing and food for the poorer population.

Understanding Public Sector Lending (PSL)

The goal of a PSL initiative is to provide credit to the weaker sections of the society, as
opposed to funding only profitable sectors or spaces that are solely important to economic
growth. All sectors considered as a public are able to easily access financial support like
apply for loans that the banks are required to allot at a lower interest rate.

The following fall into the public sectors under the policy: agriculture (including micro
financing groups like SHGs, JLGs, individual farmers, and other institutions dedicated to
individuals working in the sector), micro, small and medium scale enterprises (MSMEs)
and SSIs, Educational and Small-Scale Industrial loans, Housing loans and other micro
credit finances.

6
When banks overreach their PSL targets and need additional funding to raise funds for the
public sectors, they are able to issue PSL certificates (PSLCs) only to the extent of the
amount banks are allowed to lend in that specific sector. These certificates can be traded
on RBI’s e-Kuber platform.

Highlights of Public Sector Lending (PSL)

For 2020, the RBI sought channelling funds for the startup sector.

When introduced, only public sector banks were required to focus on the development of
the predetermined public sectors; though now private and foreign banks are also required
to provide adequate care and credit.

The way PSLCs are traded is similar to the workings of the money market, where issuing
these certificates will help banks raise money. Surplus banks may be incentivized in the
process, and banks facing cash shortfall may finance their short-term needs.

Categories of PSL

The broad categories of public sector for all scheduled commercial banks are as under:

(i) Agriculture and Allied Activities (Direct and Indirect finance): Direct finance to
agriculture shall include short, medium and long term loans given for agriculture and allied
activities directly to individual farmers, Self-Help Groups (SHGs) or Joint Liability
Groups (JLGs) of individual farmers without limit and to others (such as corporate,
partnership firms and institutions) up to Rs. 20 lakh, for taking up agriculture/allied
activities.

7
Indirect finance to agriculture shall include loans given for agriculture and allied activities
as specified in Section I, appended.

This distinction between direct and indirect agriculture is dispensed with. Instead, the
lending to agriculture sector has been re-defined to include

(i) Farm Credit (which will include short-term crop loans and medium/long-term credit to
farmers)

(ii) Agriculture Infrastructure and

(iii) Ancillary Activities,

(ii) Small Scale Industries (Direct and Indirect Finance): Direct finance to small scale
industries (SSI) shall include all loans given to SSI units which are engaged in manufacture,
processing or preservation of goods and whose investment in plant and machinery (original
cost) excluding land and building does not exceed the amounts specified in Section I,
appended.

Indirect finance to SSI shall include finance to any person providing inputs to or marketing
the output of artisans, village and cottage industries, hand-looms and to cooperatives of
producers in this sector.

(iii) Small Business / Service Enterprises: shall include small business, retail trade,
professional & self-employed persons, small road & water transport operators and other
service enterprises as per the definition given in Section I and other enterprises that are
engaged in providing or rendering of services, and whose investment in equipment does
not exceed the amount specified in Section I, appended.

(iv) Micro Credit : Provision of credit and other financial services and products of very
small amounts not exceeding Rs. 50,000 per borrower to the poor in rural, semi-urban and
urban areas, either directly or through a group mechanism, for enabling them to improve
their living standards, will constitute micro credit.

8
(v) Education loans: Education loans include loans and advances granted to only
individuals for educational purposes up to Rs. 10 lakh for studies in India and Rs. 20 lakh
for studies abroad, and do not include those granted to institutions;

(vi) Housing loans: Loans up to Rs. 35 lakhs in metropolitan cities where population is
above 10 lakh and Rs. 25 Lakh at other center s for construction/purchase of a dwelling
unit per family provided total cost of the unit in metropolitan centres and at other centres
does not exceed Rs. 45 Lacs and Rs. 30 Lacs respectively. (Excluding loans granted by
banks to their own employees) and loans given for repairs to the damaged houses of
individuals up to Rs.5 lakh in metropolitan centres and Rs. 2 Lakh at other centres.

(2) Investments by banks in securitised assets, representing loans to agriculture (direct or

indirect), small scale industries (direct or indirect) and housing, shall be eligible for
classification under respective categories of public sector (direct or indirect) depending on
the underlying assets, provided the securitised assets are originated by banks and financial
institutions and fulfill the Reserve Bank of India guidelines on securitisation.

(3) Under Weaker Sections : Public sector loans to the following borrowers are considered
under Weaker Sections category:-

(a) Small and marginal farmers;

(b) Artisans, village and cottage industries where individual credit limits do not exceed Rs
1 Lakh ;

(c) Beneficiaries of Swarnajayanti Gram Swarozgar Yojana (SGSY), now National Rural
Livelihood Mission (NRLM);

(d) Scheduled Castes and Scheduled Tribes;

9
(e) Beneficiaries of Differential Rate of Interest (DRI) scheme;

(f) Beneficiaries under Swarna Jayanti Shahari Rozgar Yojana (SJSRY);

(g) Beneficiaries under the Scheme for Rehabilitation of Manual Scavengers (SRMS);

(h) Loans to Self Help Groups;

(i) Loans to distressed farmers indebted to non-institutional lenders;

(j) Loans to distressed persons other than farmers not exceeding Rs 1 Lakh per borrower to
prepay their debt to non-institutional lenders;

(k) Loans to individual women beneficiaries up to Rs 1 Lakh per borrower.

(l) Account holders under Pradhan Mantri Jan Dhan Yojana (PMJDY)

(vii) Renewable energy sector has also been added to public sector lending in the year 2015.

Public Sector Lending (PSL)

Public Sector refers to those sectors which the Government of India and Reserve Bank of
India consider as important for the development of the basic needs of the country. They are
assigned public over other sectors. The banks are mandated to encourage the growth of
such sectors with adequate and timely credit.

The Public Sector Lending classifications and guidelines released by the RBI are intended
to align with emerging national priorities and bring a sharper focus on inclusive
development, building a consensus among all stakeholders.

10
It enables better credit penetration to credit deficient areas, increased lending to small and
marginal farmers and weaker sections, boost credit to renewable energy, and health
infrastructure and allied sectors that need credit boost, which is otherwise difficult to avail.

Why is it in News?

With the government providing the necessary impetus to green mobility, the Electric
Vehicle(EV) sector is expected to see a boom. In order to enable credit facilities and
promote faster adoption of the technology, institutional policies and mechanisms are
formulated.

In recent times, the Reserve Bank of India is said to be considering a proposal from the
government’s policy think tank NITI Aayog to categorize loans to purchase electric
vehicles under the public sector lending segment.

This is important from the UPSC perspective also. In this article, we shall be discussing
various aspects, the importance of the topic. Further, this article covers other important
dimensions, keeping in mind the demands of the preliminary as well as a Main examination
of the UPSC IAS Exam.

What are the Different Categories of the Public Sector?

• Agriculture

• Micro, Small and Medium Enterprises

• Export Credit

11
• Education

• Housing

• Social Infrastructure

• Renewable Energy

• Others

What is its History?

• The origins of Public Sector Lending is traced back to 1966

• The then government felt the need for increasing credit to agriculture and small
industries.

• However, the definition for Public Sector was only formalized based on a Reserve Bank
of India (RBI) report in the National Credit Council in 1972.

• After bank nationalization, the Public Sector formulation also allowed the government
to focus on different sectors by making credit available, through direct lending.

• Over the years the classification of the Public Sector has evolved primarily from
agriculture and small industries (MSME) to various other domains till today.

What are the Weaker Sections under the Public Sector?

• Public sector loans to the following borrowers are treated under the Weaker Sections
category

12
• Small and Marginal Farmers.

• Artisans, village and cottage industries where individual credit limits do not exceed Rs
1 lakh.

• Beneficiaries under Government Sponsored Schemes such as National Rural

Livelihoods Mission (NRLM), National Urban Livelihood Mission (NULM) and Self
Employment Scheme for Rehabilitation of Manual Scavengers (SRMS)

• Scheduled Castes and Scheduled Tribes.

• Beneficiaries of the Differential Rate of Interest (DRI) scheme.

• Self Help Groups.

• Distressed farmers are indebted to non-institutional lenders.

• Distressed persons other than farmers, with loan amounts not exceeding Rs 1 lakh per
borrower to prepay their debt to non-institutional lenders.

• Individual women beneficiaries up to Rs 1 lakh per borrower.

• Persons with disabilities.

• Minority communities may be notified by the Government of India from time to time

• Overdraft availed by PMJDY account holders as per limits and conditions prescribed
by the Department of Financial Services, Ministry of Finance from time to time may
be classified under Weaker Sections.

• In States, where one of the minority communities notified is found to be in majority,

the above covers only the other notified minorities.

13
• These States, Union Territories are Punjab, Meghalaya, Mizoram, Nagaland,
Lakshadweep and Jammu & Kashmir.
Ancillary Activities

• Loans up to Rs 5 crore to co-operative societies of farmers for disposing of the produce

of members.

• Loans for setting up of Agriclinics and Agribusiness Centers.

• Loans for Food and Agro-processing up to an aggregate sanctioned limit of Rs 100
crore per borrower from the banking system.

• Bank loans to Primary Agricultural Credit Societies (PACS), Farmers’ Service

Societies (FSS) and Large-sized Adivasi Multi-Purpose Societies (LAMPS) for on-
lending to agriculture.

• Other eligible funds are with NABARD if a public sector shortfall is noticed.

Small and Marginal Farmers

• Farmers with land holdings of up to 1 hectare come under the Marginal Farmer
category.

• Farmers with a landholding of more than 1 hectare and up to 2 hectares are considered
Small Farmers.

• Landless agricultural labourers, tenant farmers, oral lessees and share-croppers.

• Loans to Self Help Groups, where groups of individual Small and Marginal farmers are
directly engaged in Agriculture and Allied Activities.

• Banks have to maintain disaggregated data of such loans.

14
• Loans to farmers’ producer companies of individual farmers, and co-operatives of
farmers directly engaged in Agriculture and Allied Activities.

• In this case, the membership of Small and Marginal Farmers is not less than 75 per cent
and their land-holding share should not be less than 75 per cent of the total land-holding.

Micro, Small and Medium Enterprises (MSMEs)

• Micro enterprises are the ones where the investment in plant and machinery or
equipment does not exceed one crore rupees and turnover does not exceed five crore
rupees.

• Small enterprises are the ones where the investment in plant and machinery or
equipment does not exceed ten crore rupees and turnover does not exceed fifty crore
rupees.

• Medium enterprise, where the investment in plant and machinery or equipment does
not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore
rupees

Bank loans to Micro, Small and Medium Enterprises, for both manufacturing and service
sectors are eligible to be classified under the public sector as per the following-

• Manufacturing Enterprises

• Micro, Small and Medium Enterprises engaged in the manufacture or production of

goods to any industry specified in the first schedule to the Industries (Development
and Regulation) Act, 1951.

15
 • They are notified by the Government from time to time, such industries are defined
in terms of investment in plant and machinery.

• Service Enterprises

• Bank loans up to Rs 5 crore per unit to Micro and Small Enterprises and Rs 10 crore
to Medium Enterprises engaged in providing or rendering services.

• They are defined in terms of investment in equipment under MSME Development

Act, 2006.

• Khadi and Village Industries Sector

• All loans to units in this sector are eligible for classification under the sub-target of
7.5 per cent prescribed for Micro Enterprises under the public sector.

Education

• Loans to individuals for educational purposes, including vocational courses, not

exceeding Rs 20 lakh are considered eligible for public sector classification.

• Loans currently classified as a public sector would continue till maturity.

Housing

• Loans to individuals up to Rs 35 lakh in metropolitan centres.

• Up to Rs 25 lakh in other areas apart from Urban centres for purchase/construction of

a dwelling unit per family.

16
• The overall cost of the dwelling unit in the metropolitan centre and at other centres
should not exceed Rs 45 lakh and Rs 30 lakh respectively.

• The housing loans to banks’ employees are excluded.

• Loans up to Rs10 lakh in metropolitan centres and up to Rs 6 lakh in other centres for
repairs to damaged dwelling units conforming to the overall cost of the dwelling unit.

• Bank loans to any governmental agency for construction of dwelling units or slum
clearance and rehabilitation of slum dwellers subject to dwelling units with a carpet
area of not more than 60 sq.m.

Social infrastructure

• Loans up to a limit of Rs 5 crore per borrower for setting up schools, drinking water
facilities and sanitation facilities.

• It includes the construction/ refurbishment of household toilets and water

improvements at the household level.

• Loans up to a limit of Rs 10 crore per borrower for building health care facilities
including under Ayushman Bharat in Tier-2 to Tier-6 centres

• In the case of UCBs, the above limits are applicable only in centres having a population
of less than one lakh.

• Bank credit to Micro Finance Institutions (MFI) extended for on-lending to individuals/
members of SHGs/ JLGs for water and sanitation facilities are also eligible under these
categories, subject to certain criteria.

17
Renewable Energy

• Loans up to Rs 30 crore to borrowers for purposes such as solar-based power

generators, biomass-based power generators, windmills, micro-hydel plants.

• Non-conventional renewable energy-based public utilities like street lighting systems

and remote village electrification.

• For individual households, the loan limit is Rs 10 lakh

Others

• Loans not exceeding Rs 1.00 lakh per borrower are provided directly by banks to
individuals and individual members of SHGs when they fulfill certain criteria of annual
income.

• Loans not exceeding Rs 2.00 lakh provided directly by banks to SHG for activities other
than agriculture or MSME, such as meeting social needs, construction or repair of
houses, construction of toilets or any viable common activity started by the SHGs.

• Loans to distressed persons not exceeding Rs 1,00,000/- per borrower to prepay their
debt to non-institutional lenders.

• Loans sanctioned to State Sponsored Organizations for Scheduled Castes/ Scheduled

Tribes for the specific purpose of purchase and supply of inputs and/or the marketing
of the outputs of the beneficiaries of these organizations.

18
What is Public sector lending?

• Public Sector are those sectors that the Government of India and Reserve Bank of India
consider as important for the development of the basic needs of the country and are to
be given public over other sectors.

• So, under public sector lending, the banks are mandated to encourage the growth of
such sectors with adequate and timely credit.

Public sector lending in India: History

• The origins of public sector lending can be traced back to 1966 when Morarji Desai
saw a need for increasing credit to agriculture and small industries.

• However, the definition for public sector was formalised based on a Reserve Bank of
India (RBI) report in the National Credit Council in 1972.

• In 1974, the commercial banks were given a target of 33.33% of their ANBC, which
was increased to 404 of ANBC on the recommendations of Dr. K.S. Krishnaswamy
committee.

• After nationalisation of banks, the public sector formulation also allowed Indira
Gandhi, the then prime minister of India, to satisfy important political lobbies.

• The public sector definition grew over time, and was not just limited to important lobby
groups, but extended to cover important neglected sectors of the economy.

19
• However, despite the tweaks, till today, the classification retains a heavy focus on
agriculture and small industries (defined as micro, small and medium enterprises or
MSME).

Public sector lending categories

Public sector lending by banks in India constitutes the lending to

• Agriculture

• Micro, Small and Medium Enterprises

• Export Credit

• Education

• Housing

• Social Infrastructure

• Renewable Energy

• Others.

What is the issue?

In FY16 the Reserve Bank of India (RBI) initiated two significant steps on Public sector
lending.

20
What is public sector lending?

• Public Sector refers to those sectors of the economy which may not get timely and
adequate credit.

• Public Sector Lending is an important role given by the Reserve Bank of India (RBI)
to the banks for providing a specified portion of the bank lending to few specific sectors.

• The sectors may be agriculture and allied activities, micro and small enterprises, poor
people for housing, students for education and other low income groups and weaker
sections.

• This is essentially meant for an all round development of the economy as opposed to
focusing only on the financial sector.

• As per the RBI circular released in 2016, there are eight broad categories of the Public
Sector Lending.

They are:

(1) Agriculture
(2) Micro, Small and Medium Enterprises
(3) Export Credit
(4) Education
(5) Housing
(6) Social Infrastructure
(7) Renewable Energy
(8) Others.

21
• The others category includes personal loans to weaker section, loans to distressed
persons, loans to state sponsored organisations for SC/ST.

How is RBI revamping PSL?

• The current banking and economic situation demands a fresh round of thinking
regarding public sector lending (PSL) guidelines.

• Reserve Bank of India (RBI) initiated two significant steps.

• First, it revamped PSL norms by including some new sectors such as social
infrastructure, renewable energy and medium enterprises among others.

• Second was the introduction of the scheme of public sector lending certificates (PSLC)
to facilitate the achievement of PSL targets by banks.

• This is to incentivise banks having surplus in their public sector lending to sell this
surplus to peers that are falling short.

• The total volume traded at the end of September 2016 was about Rs 140 billion.

Whether PSL is increasing?

22
• Trends indicate that barring renewable energy and to some extent trade, credit to new
sectors has not shown any significant expansionary trend.

• During April-December 2016, RBI data indicates that the incremental credit growth to
public sector expanded at a very slow pace of 0.8 per cent.

• In FY16, public sector banks (PSB) public sector loans had registered a strong growth
of 13.4 per cent, compared to the overall PSBs’ credit growth of 2.1 per cent (renewable
energy and trade contributed most).

• On an average, the new sectors have contributed around two per cent to the public
sector lending growth.

• Despite this, in the last five years, PSBs have been unable to achieve the PSL targets.

• But private sector banks achieved their PSL target in the last three rows in a row.

• However, this may not be an appropriate comparison, as PSB PSL loan portfolio is
three times higher than their private sector banks’ counterparts.

• Further, the Nabard balance sheet for FY16 shows a total of Rs 1,89,420 crore in rural
infrastructure development fund (RIDF) and other funds being deposited by banks
because of shortfall in their PSL targets over the years.

• The amounts deposited in RIDF and other such funds are also counted
towards PSL achievement.

• However, if these amounts are excluded, the banking system will indeed have an overall
shortfall in PSL.

23
• Therefore, broadening the definition in line with the current economic conditions is
required.

• There needs to be a serious re-look at the cap of Rs 5 crore per borrower for building
social infrastructure activities like schooling in Tier II and Tier VI centres.

• The cap of Rs 15 crore for borrowers related to public utilities under renewable energy
must be increased manifold to make it a meaningful proposition in accordance with the
current vision.

• Another area worth considering is expanding the definition of rural infrastructure to

include rural roads, power plants, bridges etc.

• We should also consider including food credit under PSL as such credit is primarily
used for procurement of food grains, ensuring food security, especially for weaker
sections of society.

• Alignment of public sector guidelines with the affordable housing definition will
incentivise banks to lend more to the affordable housing segment.

• It might be worthwhile to make an objective assessment of whether we should include

municipal bonds under PSL norms.

• As it will meaningfully facilitate rising of funds for the necessary improvement in social
and economic infrastructure of cities.

24
 Chapter 2

Research Methodology

The process used to collect information and data for the purpose for making business
decisions. The methodology may include publication research, interviews, surveys and
other research techniques, and could include present and historical information.

• The project is on Public sector lending by banks Hence study has to be done on the
basis of information and news available about the sectors i.e. secondary data by various
modes.

• This research had to be completed by doing Fundamental analysis and Technical

analysis of the PSL. Secondary data was collected from the internet, company websites,
magazines and various articles.

• However, the main source of information is Annual Report issued by the companies
and also quarterly reports of the current year showing their performances in current
market scenario.

• Firstly, data was analyzed on the basis of the industry. The industry i.e. Banking focused
on and its performance and relation with the Indian economy was monitored and then
specific stocks were chosen to be invested in depending upon the fundamentals of the
company stocks. These stocks were individually analyzed and then measured whether
it would give maximum returns if invested in.

25
The methodology of study consists of

• Source of data collection

• Statistical tools and techniques

Source of data collection:

The data has been collected through primary and secondary sources

❖ primary data:

➢ Discussion with Public Sector Employee

➢ Live news from various news channel

❖ secondary data:

➢ Books related to Public Sector Lending

➢ Web sites can be used as vital information source

26
Objective

• To Study dedicate funds for specific sectors of the economy like agriculture and allied
activities, education and housing and food for the poorer population.

• To Study strengthening Cooperative Banks, Regional Rural Banks, and Microfinance

Institutions for last mile connectivity and encouraging opening of “small” banks.

• To Study promoting enablers like an extensive credit information system to create a

robust credit infrastructure and a healthy credit culture.

• To Study using technology to reduce cost of delivery to Public sectors.

Hypotheses

H0: All the selected banks of India have equal norm with respected to public Sector
Advance to Total Advances.

H1: All the selected banks of India have unequal norm with respected to public Sector
Advance to Total Advances.

Sampling Design

India has 22 banks in private sector and 20 banks in public sector.In this research sample
select by of non-probability convenient sampling method.

27
Period of Study

The study period are five years from 2018-19 to 2022-23.

Source of the Data

This research is mainly based on secondary data. The data collected from annual report of
selected banks.

Research Tool

This study used F- test ANOVA for research.

Limitations

This study has taken only two sectors for research.

1.This study based on secondary data.

2.This research covered five year only.

3.Only six banks have been taken as sample for research so do not make generalised to
entire population.

28
Sample

HDFC, ICICI, AXIS bank from private sector and BOB, BOI, SBI from public sector has
selected as a sample for the present study.

Econometric Modelling

In order to understand the impact of determinants like Bank size, Bank performance and
Lending efficiency on Public sector lending, an empirical exercise is being carried out by
taking panel data for Public sector banks in India from the period 2006-07 to 2015-16 in a
multiple linear regression framework.

• Bank size consists of the variables like Deposits, advances and Employee strength.

• Bank performance consists of the variables like CAR, ROA and NIM.

• Lending efficiency consists of the variables like C/D Ratio and Gross NPA to total assets
Ratio.

29
The Econometrics Model is written as follows:

Y= β0 + β1x 1 + β2x2 + β3x3 + β4x4 + β5x5 + β6x6 + β7x7+ β8x8 + β9x9 + β4x4 …….
+ εit

Y= Dependent variable= PSL

β0= Intercept term

β1= Co-efficient of Deposits

β2= Co-efficient of advances

β3= Co-efficient of Employee strength

β4= Co-efficient of CAR

β5= Co-efficient of ROA

β6= Co-efficient of NIM

β7= Co-efficient of C/D Ratio

β8= Co-efficient of GNPA to Assets Ratio

x 1, x2, x3, x4……..= independent variables

30
 Chapter 3

Literature review

Ahmed (2010)

Examined a Public Sector Lending by Commercial Banks in India. The study found that
the level of NPAs in public sector advances of commercial banks and the recovery
performance of public sector advances of banks over the years by the statistical tools like
correlation analysis, regression analysis, growth rate analysis, parametric tests. He
concluded that the banks are not able to reach the prescribed target of lending to public
sector. Dave (2016) Analysed public sector lending for selected public sector banks of
India. To explore public sector lending for selected bank like SBI, PNB, CANARA bank,
BOB and BOI. He used statistical tool F test- one way ANOVA. He found that the lending
activity towards public sector by the total selected banks are following the norms for
advances to public sector on an average nearer one fourth to one third of their total advances
during the research period.

Solanki (2016)

Analysed Public sector lending by commercial bank in India. The study examined the past
and present position of the public sector lending. Also found that the volume and trend of
the public sector lending by Statistical tools ENOVA test. He used convenient sampling.
The research concluded that no significant different in public sector lending between
selected bank.

Uppal (2009)

Explore Public sector advances in Trends, issues and strategies. The research found that the
public sector lending and targets achieved by various bank groups. He used financial data

31
of public banks, private banks and foreign banks. The researcher concluded that public
sector advances of all the banking groups are increasing.

Berger and Black (2010)

go on to say that while the smaller banks have a comparative advantage in lending based
on relationship or soft basis, but this could also include "judgment" lending. Herein,
judgment of the lending officer based upon his experience and training, is used to assess
and extend loans.

Berger and Udell (2006)

in their study assess the issue of credit availability to small and medium enterprises (SMEs)
in a holistic manner, rather than in a narrow sense. Lending technologies, as defined in
terms of procuring information, screening them, structuring loan contracts and monitoring
mechanisms, are viewed as a conduit to enable varying government policies and financial
structures to translate to credit availability to SMEs. The study underlines the importance
of considering not only bank size, but also its nature of ownership and the lending
environment to explain their varying lending technologies, and hence credit availability to
smaller firms

Bhattacharya A, 1995

had done a study to study the impact of liberalization on the efficiency of banks. The study
told that the objective behind liberalization was to increase public sector lending to increase
the economic and social benefits. Study reflected the fact that PSL of public sector banks
was quite high and it had no negative effect on the performance of public banks. PSL of
private and foreign banks was less and it has also negative effect on the performance of
these banks in the study period.

32
Shajahan K, 1998

revealed in his study that till 1954 only 7.3% of agriculture loans were through institutional
advance while agriculture share in income was 50%. In 1969 with the nationalization of
banks, major changes had been done in the economic system like targets were being fixed
for the specific sectors of economy. In March, 1979 33.3% target has been fixed for PSL.
In 1983 agriculture target was being fixed 18% of PSL. In 1995 RIDF has been established.
Banks were advised to submit the shortfall PSL target in it. Due to PSL agriculture advances
increased manifold.

Uma s. ,2001

has conducted a Ph D study in Banglore district with a special reference of SSI public
lending. Researcher studied the impact of PSL on productivity, employment, capital,
profitability and intensity of small scale industries. The sample is divided in to two parts:
beneficiaries and non beneficiaries. Researcher found an appropriate increase in income
and profitability of beneficiaries units of small scale units than non beneficiaries units.

Sathye Milinid, 2002

done a study to know the efficiency of banks in a developing country like India and to
compare the Indian banks efficiency with foreign banks. The author used DEA (Data
Envelopment Analysis) Approach. The main findings are that banks efficiency in India is
lower than in France and UK; and the mean efficiency score of Indian bank is lower than
international bank efficiency score. The main reason of this lower efficiency is Public sector
lending.

Dasgupta Rajaram, 2002

33
done a comparative study of PSL before reform period (1991) and post reform period. The
author found that earlier to 1991 agriculture loans were used for small and marginal
farmers, now it is being shifted to big and medium farmers. Earlier to 1991 there is no
concept of indirect agriculture advances. After 1991 SSI limits has been increased, but it
can be understood due to inflationary pressure. Before 1991 PSL is targeted to neglected
sector of economy, but now in agriculture sector definition is changed.

Attaullah Ali, Cockerill Tony and Le Hang, 2004

compared the efficiency of Indian and Pakistani banks and tried to find out the reasons of
lower efficiency scores of banks of both the countries. The author used DEA (Data
Envelopment Analysis) Approach. It is found that in both countries efficiency of banks
have increased but still less than international efficiency of banks. Major reason of low
efficiency of bank is Non Performing Assets. NPA occurs due to political pressure, pressure
on bank manager to give loans to those projects which are not economical viable, legal
bindings on banks to directed lending, bad recovery system and economic conditions of the
countries.

Burgess Robin, Pande Rohini8, Wong Grace, 2005 found in their study that directs
lending program help in reducing poverty through branch expansion.

Reserve Bank of India had draft a technical paper on PSL, 2005.

In the paper it has been found that initially commercial banks are focusing on industries
and export segment of PSL not on Agriculture sector. It was also revealed in the paper that
internationality other countries like Japan, Korea, China, Brazil and Indonesia has stared

34
the PSL in form of direct lending, but in most of countries this is not successful, So most
of the countries have stopped PSL.

Basu Priya, 2005

has done a study on Indian Financial System; the main focus of the study was to know
whether the Indian financial system is successful to help the poor or not. In this study she
found that in PSL category bank are fulfilling the targets by investments in NABARD and
SIDBI. The study also showed that in PSL category itself the rich farmers are getting benefit
not small and marginal farmers. Banks also don’t want to give small loans. This study also
show some major issue like bribes, delay in giving loans, political interference while
disbursing loans by banks.

Mohua Roy, 2005

reviewed the trend of bank lending to PSL and found that till 2005 agriculture PSL is
constant and SSI PSL is showing a decreasing trend. The author also found that in
agriculture PSL sector there is a trend of wilful default, so NPA is increasing in this sector.

Das Abhiman, Ghosh Saibal 2006

revealed that a huge quantum of Indian banks credit go to public sector, which has a less
interest rate, which decrease the profitability of banks. The author used DEA analysis.

Kaur Jasmindeep, Silony, 2011

35
had reviewed the performance of commercial banks with reference to PSL after reforms
era. The researcher analyzed that post reforms PSL of private banks grew faster than public
banks. The study also conclude that before 2002 main focus of PSL was on Agriculture
sector but after 2002-03, both public and private banks focused on service sector, as this
sector emerge as a leading factor for economic development. The study also compared the
PSL NPAs of public and private banks and concludes that PSL NPA of public banks was
more than private banks. The study was based on secondary data which has been collected
through ‘Report on Trend and Progress of Banking in India’ for the various years. The
period of the study was 1990-91 to 2007-08.

Raman P., Thangavel N., 2011

conducted a study on social banking of India. This study was an attempt to know whether
the Public Sector Lending was able to achieve the social banking objective of RBI or not.
This study found that in some extent it was successful like Branch expansion in rural areas,
Credit to Micro and Small enterprises, Women Entrepreneurs, Sponsored Regional Rural
Banks and advances to weaker section. But according to this study PSL was not successful
in some areas like agriculture. This study said that the number of dependent persons on
agriculture for food and livelihood remain unchanged but still banks are not able to fulfill
the mandatory target of 18% in agriculture PSL.

Ghosh, 2011

found in his study that Public sectors like agriculture, SSI and others are also a reason of
increasing NPA of Public and Private sector banks.

Kaur, J. 2012

studied the growth of PSL in Punjab from 1991 to 2011. The researcher studied the view
of 300 beneficiaries of the field and 48 managers of selected banks. The research found
various factors which are responsible for negative performance of PSL such as inadequacy
of loans, illegal payment, rate of interest and delay in disbursement of loans. It is also found
in the study that agriculture advance of both public and private banks has increased in study
period but it was 12 to 15% for public banks and 12 to 13% for private banks. It means both

36
public and private banks were not able to fulfil the mandatory 18 % target in agriculture. It
was also found that both public and private banks believe that NPA was more in PSL. The
study also found that most of the beneficiaries are not satisfied with the behaviour of banks.

Patidar Suresh, Kataria Ashwini, 2012

had analyzed the effect of Public Sector Lending on Non performing assets of banks. The
study was a comparison of NPA of PSL of public and private banks. The data was collected
through secondary sources like internet, related books, case studies and research articles.
Researchers used regression analysis and fitted a linear relationship between PSL and NPA.
Researcher found that PSL of both public and private banks public sector advances
increased in study period, the reason for increase in PSL was mandatory target fixed by
RBI. Using Regression analysis it was clear that PSL had significant impact over NPA.

Shabbir N., 2013

conducted a study to know the sector wise public advances in India. The researcher
objective was to check the willingness of the banks to lend to public sector and to know
whether the banks were lending to the public sector by direct means or indirect means. The
study show that lending to agriculture had increased but lending to agriculture through
direct means had decreased. The study showed that the willingness of banks to lend to
public sector has increased Rajeshwari G, 201322 had found in her Ph. D. work that in the
study period (2001 to 2011) banks are fulfilling the PSL targets. PSL of private banks are
declining in the study area. Banks are failed to fulfill the PSL targets in crop loans instead
of demand. The study also showed that there is less awareness about the schemes of PSL
in the study area.

Selvam N, 2013,

37
done a study on customer perception regarding NPA of commercial banks, author found
that customer also feel that social and political pressure in form of PSL also play a major
role in increasing NPA Banerjee Abhijit, Duflow Esther24, 2014 found in their study that
in PSL more administrative and labor cost was involved. The study said that PSL had a less
interest rate then market borrowing which had a direct effect on profitability of banking
firms.

Dhar Satyajit, Bakshi Avijit, 2015

done a study to know the main determinants of NPA of Indian banks. The study revealed
that there are various factors responsible for NPAs such as lack of infrastructure, bad
recovery system, not proper appraisal of loan proposal, and willful default in hope of debt
relief, lack of iniative by bank officials and use of loan amount for different purpose. The
study also reveals that there was no role of PSL in raising NPA.

Kumar and Francisco (2005)

found that smaller firms have more difficulty in credit access and have more credit
constraints, and state-owned banks are more likely to lend to larger firms. Thus,
government intervention in ownership of banks may not be very favorable for lending to
small and information ally opaque firms.

Banerjee and Duflo (2004, 2014)

found that the small firms are credit constrained, and that the banks also find such lending
profitable. In spite of this, banks are reluctant to increase the amount of lending and
especially to new firms, mainly to avoid possible action against them for bad decisions
(good performance anyway does not attract enough rewards). This may as well be peculiar
to public sector banks.

38
 CHAPTER 4
Data Analysis, Interpretation and Presentation

Banking sector plays an active and important role in the development and growth of nation.
The contribution of banks to Indian economic development through public sector lending
is remarkable. The public sector lending was evolved and commercial banks were advised
to Grand at least 40% of their total advance to borrowers in the public sector. Public sector
means to those sectors of the economy which may not get timely and equal credit in the
absence of this special division. This is essentially meant for an all-round development of
the nation economy as opposed to focusing only on the financial sector.

The Public sector is broad categories for all scheduled commercial banks are as
under:

Agriculture and Allied Activities (Direct and Indirect finance)

Direct finance to agriculture shall include short, medium and long term loans given for
agriculture and allied activities directly to individual farmers, Self-Help Groups or Joint
Liability Groups of individual farmers without limit and to others (such as corporate,
partnership firms and institutions) up to Rs. 20 lakh, for taking up agriculture and allied
activities. Indirect finance means agriculture shall include loans given for agriculture and
allied activities as specified in Section I, appended.

Small Scale Industries (Direct and Indirect Finance)

Direct finance means small scale industries shall include all loans given to Small Scale
Industries units which are engaged in manufacture, processing of goods and whose

39
investment in plant and machinery (original cost) excluding land and building does not
exceed the amounts specified in Section I, appended. Indirect finance means Small Scale
Industries shall include finance to any person providing inputs to or marketing the output
of village and cottage industries, hand-looms and to cooperatives of producers in this sector.
International Journal of Research in all Subjects in Multi Languages

Small Business and Service Enterprises

In this category include retail trade, small business, professional & self-employed persons,
small road & water transport operators and other service enterprises as per the definition
given in Section I and other enterprises that are engaged in providing or rendering of
services, and whose investment in equipment does not exceed the amount specified in
Section I, appended.

Micro Credit

Provision of credit and other financial services and products of very small amounts not
exceeding Rs. 50,000 per borrower to the poor in rural, semi-urban and urban areas, either
directly or through a group mechanism, for enabling them to improve their living standards,
will constitute micro credit.

Education loans

Education loans include loans and advances granted to only individuals for educational
purposes up to Rs. 10 lakh for studies in India and Rs. 20 lakh for studies abroad, and do
not include those granted to institutions.

40
Housing loans

1. Loans up to Rs. 35 lakh in metropolitan cities where population is above 10 lakh and Rs.
25 Lakh at other center s for construction/purchase of a dwelling unit per family provided
total cost of the unit in metropolitan centres and at other centres does not exceed Rs. 45
Lacs and Rs. 30 Lacs respectively. (excluding loans granted by banks to their own
employees) and loans given for repairs to the damaged houses of individuals up to Rs.5
lakh in metropolitan centres and Rs. 2 Lakh at other centres.

2. Investments by banks in securitised assets, representing loans to agriculture (direct or

indirect), small scale industries (direct or indirect) and housing, will be eligible for
classification under respective categories of public sector (direct or indirect) depending on
the underlying assets, provided the securitised assets are originated by banks and financial
institutions and fulfill the Reserve Bank of India guidelines on securitisation.

3. Under Weaker Sections Public sector loans to the following borrowers are considered
under Weaker Sections category:-

(a) Small and marginal farmers

(b) Artisans, village and cottage industries where individual credit limits do not exceed Rs
1 Lakh

(c) National Rural Livelihood Mission (NRLM)

(d) Scheduled Castes and Scheduled Tribes

(e) Beneficiaries of Differential Rate of Interest (DRI) scheme

(f) Beneficiaries under Swarna Jayanti Shahari RozgarYojana (SJSRY)

(g) Beneficiaries under the Scheme for Rehabilitation of Manual Scavengers (SRMS)

41
(h) Loans to Self Help Groups

(i) Loans to distressed farmers indebted to non-institutional lenders

(j) Loans to distressed persons other than farmers not exceeding Rs 1 Lakh per borrower to
prepay their debt to non-institutional lenders

(k) Loans to individual women beneficiaries up to Rs 1 Lakh per borrower.

(l) Account holders under Pradhan Mantri Jan DhanYojana (PMJDY)

(m) Renewable energy sector has also been added to public sector lending in the year 2015.

The work titled ‘public sector lending in India’ primarily focuses on understanding the
concept of public sector lending (hereinafter PSL) or directed lending. It focuses on the
informative approach and tries to answer few necessary questions in order to explore the
concept of PSL and its presence in Indian governance.

The aforesaid necessary questions are

what is meant by PSL?

Is there a relation between Public sector measure such as PSL and the constitutional scheme
of India?

What are the sectors which are considered to be of ‘public’?

How has the concept of ‘public sector lending’ being enforced in India?

What have been the advantages and disadvantages of the PSL in India in terms of its
impacts on the economy on the countries?

Whether the trend on inclusions in the public sector lending is deviating the focus from the
core needy sectors of the economy?

And is there a need to review the concept and scope of public sector lending?

The concept of ‘public sector lending’ focuses on the idea of directing the lending of the
banks towards few specified sectors and activities in the economy. One belief which forms
the cornerstone behind the philosophy of public sector lending is that banks are believed to
be the movers of economic growth and that by regulating them the whole economy can be

42
given a different a different shape and texture. The term ‘public sector’ indicates those
activities which have national importance and have been assigned public for development.
These primarily include agriculture, small industries etc. The case has further been that
these sectors and activities were neglected ones for the purpose of bank credit and therefore
for the purposes of accessibility of credit, these neglected ones are considered to be at public
for providing credit. The Reserve Bank of India, which is the supervisory body of the
banking sector in India, also referred to as the Apex Bank of the country, has from time to
time issues instructions/guidelines/directives to the banks in India with regard to the public
sector lending. The scope and extent of the PSL has undergone a significant change in the
post-reform period with several new areas and sectors being brought under its purview
while there has been demands to include new areas, such as infrastructure, within the ambit
of public sector, there is an apprehension that it will dilute the definition of public sector
with the focus on the needy sectors of the economy and weaker section of the society getting
lost.

History And Journey of Public Sector Lending in India

The bend of the governance in India towards ‘socialist principles’ and ‘socialism’ was quite
evident in the post-independence era especially after the coming into force of the great
document called “The Constitution of India” which inherently provided the aims and
guidelines of inclusive growth and development through the ‘directive principles of state
policy’ and the scheme of the Constitution.

The most primary sector of economy at that point in time i.e. agriculture was in need of

Presently, the total PSL contribution for domestic scheduled commercial banks and the
foreign banks with 20 branches and above is 40 percent of the ANBC or Credit Equivalent
Amount of Off-Balance Sheet Exposure, whichever is higher and the foreign banks with

43
less than 20 branches have to achieve this target of 40 percent in a phased manner by 2020.
The Sub-targets fixed are 18 percent for Agriculture sector, 7.5 percent for the Micro
Enterprises and 10 percent in the category of ‘Advances to Weaker Sections’.

Impacts of The Directed Lending/ PSL on The Banking Sector And The
Economy-

The advocates of PSL claim that it lifts up the weaker sector which the market forces
usually fail to do. It is also claimed that PSL results in social returns and improved lending
portfolios of the banks. The directed lending allows the commercial banks to generate high
social returns along with the profits and it also contributes to economic development by
increasing investment in the strategic sectors, like exports. Most important of all, from the
viewpoint of public policy, the directed lending promotes social equity and facilitates
increase in employment and investment in less developed regions and the vulnerable
sections of the society. The opponents, on the other hand believe that it diverts funds from
the productive sectors, imposes economic burdens on the banks in the form of loan losses
and payment defaults and also imposes opportunity costs of lending to non-Public sectors
of the economy. These negative effects are increased transaction costs, increased NPAs and
the decreased deposit mobilization. Since the subsidized nature of loans under the directed
credit forces the banks to pay lower interest rates on deposits, this makes the deposits a less
attractive avenue for the people which ultimately impacts the banks. In cases like India,
where the capital markets are not much developed and multiple demands of credits arises
from various sectors, these quantitative targets based on the proportion of gross advances
effects lending to equally important sectors such as infrastructure.

·Public Sector Lending and the problem of NPAs –

Non-performing assets are those assets of the bank which cease to provide any return to the

44
bank. NPAs, now days, have become a big problem for the banks as it has been a major
concern for the bank promoters and government. The RBI defines a NPA as a credit facility
with interest or principal instalments overdue for 90 days.The NPA ratio has an inverse
relation with the asset quality of the bank. The NPA ratio for the public banks is much
higher (almost thrice) when compared with the private and the foreign banks. It is actually
so given the vast scale of lending which a public bank provides across the nation. In PSL,
the banks have little power in allocating the credit, and must lend to sectors marked by a
relatively large number of defaults due to factors specific to those sectors. The banks then
have to set aside the capital to account for assets that might be decreased due to NPAs
which erodes the profitability of the banks.

Apart from NPAs, there are other indirect costs on the banking industry by a sort of
penalizing the banks for expanding their scale of lending. Since the computation of the PSL
target of the bank is based on the previous year’s Adjusted Net Bank Credit (ANBC), it
deters banks from expanding their current year’s scale of lending because it would
ultimately increase the bank’s PSL target for the next year.
There are also few direct costs involved due to PSL which are the funding cost, the
transaction cost and the credit costs which the banks have to borne. Here, transaction cost
is the cost of delivering the credit to the borrower which includes wages, salaries, printing,
rent, electricity, connectivity, transportation of cash, insurance, overhead and depreciation
etc. For Public sectors, especially agriculture, loans are often small and the number of
borrowers are large, which increases the transaction cost for delivering the credit.

Review of PSL In India

Can the PSL as a concept and as a practice be ‘reprioritized’? Is there a need to review
the concept and segment of Public sector lending?

45
The norms of PSL find their origin in the ‘social control over banking’ philosophy which
could have been justified according to then prevailing situations in the country. The
conceptually, PSL was a compromise which the banks had to make with the profitability as
per the norms by the RBI in order to carry on the banking business in India and overtime
the norms of PSL were made mandatory to both the public sector and the private sector
banks and also to the foreign banks (with certain exceptions) which highlighted that
irrespective of the business model of the banks and even in ignorance of other factors such
as branch availability etc. the targets and sub-targets of the PSL norms were made
applicable to the banks (which continues to be done till now).

It has been long enough since all banks are made to do public function in the form of PSL
which is affecting their profitability to a great extent and it is time that this ‘public function’
approach be restricted to the public sector banks and the State Bank of India and the private
banks be given a free hand to decide on their investment/lending avenues so that a right
balance is struck between pursing profitability and fulfilment of the public functions. What
needs to be emphasized is that the profitability of the banks be given due importance by the
policy makers since PSL is a costly affair for the banks and it becomes a bitter pill to
swallow not only for the banks but also for the whole economy. The following steps can
prove beneficial in this regard-

·The scheme of PSL (the fixation of the targets and the sub-targets) must be structured
according to the type of bank along various other considerations such as branch
availability and the willingness of the bank to lend to a particular sector.

Historically, a crucial difference between the public and private sector banks has been with
regard to the willingness to lend to the Public sector but the broadening of the definition of
Public sector has lifted the share of credit from both the public and private sector banks

46
which qualify as Public sector. Private sector banks find it difficult to meet agricultural
lending sub-target, though they also lend substantially less in rural areas.

Therefore, requiring all banks irrespective of their business model and orientation to lend
18 percent targets to agriculture is not an efficient way to direct credit to agriculture.
Meeting this kind of sub-target would be feasible and also fairly easy task for the public
sector banks considering the vast number of branches in rural areas and also various benefit
from the government schemes. It becomes equally difficult for the foreign banks to fulfil
the targets with regard to agriculture since they neither have expertise nor the branch
network in rural areas like the public sector banks. However, ‘export credit’ is where they
have expertise and this may be designated as the Public sector for them. This would enable
efficiency to the foreign banks. The PSL norms may sometimes become a disincentive for
the foreign banks and may deter them from opening branches in the country. It must be
seen that the foreign banks neither have the expertise nor sufficient means to lend to the
agricultural sector and therefore the revised PSL guidelines which subject the foreign banks
with more than 20 branches to the same lending requirements as domestic banks do not
appear logical and facilitative to the growth of banking sector in India. It would be
progressive to specify other sectors as Public sector for the foreign banks.

·Development of Agriculture Sector as an avenue for investment by the

private and foreign investors-

It must be acknowledged that agriculture as a Public sector has a special status, a special
place other than other activities which also find place in the head of ‘Public sector’ of the
country. The reason for this are historical. It is believed that ‘India lives in villages’ and the
role of agriculture in the economy (in terms of contribution to GDP and also in terms of the
number of persons employed in the sector) cannot be ignored. The dependence of this sector
on credit has been perennial and in recent years of independence and before the inception
and implementation of the concept of PSL, the demand for credit was largely fulfilled
through the informal sources and the implications of the informal credit mechanism on the
farmers were drastic considering the possibilities of economic exploitation of the borrowers

47
(mainly farmers).
Of the total amount borrowed by the cultivators in 1951-52, nearly 70 percent was
contributed from the moneylenders, only one percent came from the commercial banks and
about 3 percent came each from the government and the cooperatives. The situation has
increased considerably from the previous situation and now most part of the credit is made
available by the formal banking mechanism. To develop the agriculture sector, efforts may
be made towards providing effective risk cover to agriculture and to make it more attractive
avenue of investment for the private and foreign Investors. Development of rural
infrastructure in the form of water, electricity, transport and sanitation infrastructure in rural
areas would attract investments into the sector. Encouragement of ‘contact farming’ as an
alternate risk management instrument would attract private sector participation and also
reduce dependence of the farmers on the formal banking credit. Work can also be done
towards strengthening the cooperative banks, regional rural banks and microfinance
institutions and also encouraging the opening of ‘small’ finance banks.

The outstanding Public sector advances of PSBs increased by 21 per cent in 2003-04 as
against an increase of 18.6 per cent during 2002-03. During the period 1995-2004, the
average annual growth rate of advances to Public sector by public sector banks was 17.6
per cent as compared to average growth rate of NBC at 16.7 per cent in the same period.
The higher growth in Public sector advances of PSBs during the above period was primarily
due to 28.8 per cent average growth rate recorded by other Public sectors which
compensated for the low average growth rate in credit to SSI (9.3 per cent) and direct
agriculture credit (15.7 per cent).

The share of Public sector advances in NBC of PSBs increased to 44 per cent in 2003-04
from 42.5 per cent in 2002-03. The growth in Public sector advances of PSBs was fuelled
by the surge in the loans and advances to various other Public sectors and robust growth of
credit to the agriculture sector.

Advances to agriculture constituted 15.4 per cent of NBC of PSBs as on the last reporting
Friday of March 2003 (Annexure 6). The share of advances to other Public sectors in NBC
of PSBs increased to 17.0 per cent in 2003-04 from 15.0 per cent in 2002-03. The number

48
of accounts covered under various major segments (agriculture, SSI and other Public
sectors) of Public sector declined over the period.

Table 1: Outstanding credit to Public sector lendings by PSBs Rs. In Crores

Year PSB As % of ANBC
2001 1,46,546 43
2002 1,71,185 43.1
2003 2,03,095 42.5
2004 2,45,672 44
2005 3,10,093 43.2
2006 4,10,379 40.3
2007 5,21,180 39.6
2008 6,08,963 44.6
2009 7,19,497 42.5
2010 8,64,562 41.7
2011 10,28,615 41.3
2012 11,29,990 37.4
2013 12,84,880 36.4
2014 16,18,971 39.4

Source: RBI, Reports on trends and progress on banking in India,

49
 1800000
1600000
1400000
1200000
1000000
Year
800000
PSL
600000
400000
200000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14

Chart 1: Outstanding credit to Public sector lending by PSBs Rs. In Crores

Table 2: Total agricultural credit by PSBs in India. (Rs. In Crores)

Year PSB As % of ANBC
2001 53685 15.7
2002 63082 15.9
2003 73507 15.4
2004 86186 15.4
2005 112474 15.7
2006 154900 15.2
2007 205090 15.6
2008 248685 18.2
2009 296856 17.5
2010 370729 17.9
2011 414990 16.6
2012 475148 15.7
2013 532801 15.1
2014 687242 16.7
Source: RBI, Reports on trends and progress on banking in India,

50
The Government of India initiated measures for social control over banks in 1967-68 with
a view to securing a better adaptation of the banking system to the needs of economic
planning and its playing a more active and positive role in aiding sectors like agriculture
and small scale industries (SSI). One of the objectives of nationalisation of banks was to
ensure that no viable productive endeavour should falter for lack of credit support,
irrespective of the fact whether the borrower was big or small. Thus, the concept of Public
sector lending was evolved further to ensure that assistance from the banking system flowed
in an increasing manner to the vital sectors of the economy and according to national
priorities.

Table 3: Bank loans to medium enterprises (no. of A/c in Lakhs and Amt in Rs. Crores)
Quarter Public Sector Banks
Ended No. of A/c Amt. O/s
Mar.2011 0.46 109146
Mar.2012 0.68 136286
Mar.2013 0.77 141066
Mar.2014 0.46 138415
Source: RBI

Empirical Analysis

Descriptive Statistics

Descriptive analysis shows the mean, and standard deviation of the different variables of
interest in this study. It also presents the minimum and maximum values of the variables

51
which help in getting a picture about the maximum and minimum values a variable has
achieved.

Regression Analysis

Y= β0 + β1x 1 + β2x2 + β3x3 + β4x4 + β5x5 + β6x6 + β7x7+ β8x8 + β9x9 + β4x4 …….
+ εit

Y= Dependent variable= PSL

β0= Intercept term β1= Co-
efficient of Deposits β2= Co-
efficient of advances β3= Co-
efficient of Employee strength
β4= Co-efficient of CAR β5=
Co-efficient of ROA β6= Co-
efficient of NIM β7= Co-
efficient of C/D Ratio
β8= Co-efficient of GNPA to Assets Ratio

x 1, x2, x3,X4……..= Independent variables

Result

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.99
R Square 0.98
Adjusted R Square 0.79
Standard Error 0.86
Observations 10.00

52
Standard
Coefficients Error t Stat P-value
Intercept -1.8890 45.6198 -0.0414 0.9737
DEPOSIT 0.0189 0.0166 1.1402 0.4584
ADVANCES -0.0010 0.0006 -1.8299 0.3184
EMPLOYEE
STRENGTH 0.0001 0.0001 1.0389 0.4879
CAR 0.2323 0.5223 0.4447 0.7336
ROA -19.8432 15.1663 -1.3084 0.4155
NIM 1.9827 1.8857 1.0514 0.4840
C/D RATIO 0.4079 0.6833 0.5970 0.6573
NNPA TO
ASSETS -2.7577 2.4040 -1.1471 0.4564

ANOVA

df SS MS F Significance
F

Regression 8 30.01 3.75 5.11 0.33

Residual 1 0.73 0.73

Total 9 30.74

Equation

53
PSL = -1.8890 + 0.0189* DEPOSIT+ -0.0010 * ADVANCES + 0.0001* EMPLOYEE

STRENGTH + 0.2323 * CAR+ -19.8432* ROA + 1.9827 * NIM+ 0.4079 * C/D RATIO
+-

2.7577* NNPA TO ASSETS + εit

2
R of 0.98 implies that the eight independent variables are collectively able to explain 98%
Variation in PSL.

F-statistic of 5.11 and Sig. (F-Statistic) value of 0.33 shows that the model has statistically
significant explanatory power.

Intercept value of -1.8890 is the value of ratio of Total PSL of a company on an average
when values of all independent variables are equal to 0.

Test of Hypothesis

PSL and Bank Size

Bank size consists of Deposits, advances and employee strength. From this result it is
observed that Deposits positively affects PSL. But the impact is insignificant. ( P- Value is
0.4584 ). Similarly Advances shows a negative relationship and Employee strength shows
a positive but a very low impact with Public sector lending. So overall we can say there is
a positive relationship (although it is not significant) between bank size and PSL. That
indicates if the bank size increases lending to Public sector will also increase and vice versa.
So H1 is accepted.

54
PSL and Bank Performance

Bank performance consists of CAR, ROA and NIM. From this result it is found that CAR
positively affects PSL. But the impact is insignificant.

Similarly ROA shows a negative relationship and NIM shows a positive but insignificant
with Public sector lending. So overall we can say that here also is a positive relationship
(although it is not significant) between bank performance and PSL. That indicates if the
bank performance increases lending to Public sector will also increase and vice versa. So
H1 is accepted.

PSL and Lending Efficiency

Lending efficiency consists of C/D Ratio and GNPA to Assets Ratio. From this result it is
found that C/D Ratio positively affects PSL. But the impact is insignificant.

Similarly GNPA shows a negative relationship but insignificant with Public sector lending.
So overall we can say that here also is a Negative relationship (although it is not significant)
between lending efficiency and PSL. That indicates if the Gross NPA Ratio decreases
lending to Public sector increases or vice versa. So H1 is rejected.

Major Findings

55
The findings of the study suggest that banks in general, have complied with the total PSL
targets, with private sector banks performing better in this regard. However, they all have
been unable to comply with the sectoral targets for agriculture and weaker section lending,
with public sector banks being slightly better in this regard. Bank size and bank
performance show a positive relationship with Public sector lending where as lending
efficiency of banks depicts a negative relationship with PSL. And the whole relationship
was not significant.

Based on the findings from the study, a number of policy recommendations can be made
for improving the effectiveness of PSL program. Some of the important suggestions which
emerge from the findings are as follows. In view of the significance of bank size and nature
of ownership in PSL, it may be worthwhile considering the idea of establishing public
sector banks sponsored smaller-sized, separate entities, which are privately managed, for
lending to Public areas within the PSL program. Similar suggestion has also been made in
a few earlier studies (Berger, Miller, Petersen, Rajan and Stein, 2005). Lending to small
and rural borrowers in PSL is more aligned for relationship lending. This requires flexibility
in organization structures and policies to cater to the peculiar nature of PSL, where public
sector banks may not have a comparative advantage. Smaller, private and distinct entities
may be equipped to have greater flexibility in this regard. They may also be able to distance
themselves from political interventions. Therefore, separate entities of banks (especially of
public sector banks) may be established for PSL, to better serve its objectives. Further,
while considering proposals for consolidation in Indian banking industry, the adverse
impact of bank size on

PSL may also be considered by the government (Peek and Rosengren 1995). In view of the
significance of lending efficiency in determining PSL patterns, it is important to reorient
the human The resource (HR) policies to make them favourable for PSL. Such redesigning
of HR policies which takes into account the special characteristics of PSL can be
undertaken by the private sector banks on their own. However, for public sector banks

56
(which constitute a major part of the banking system in most developing countries), this
may require initiative/ approval of the government. It may be emphasized that there is an
urgent need to redesign HR policies to ensure higher PSL.

What are Activities Covered under Public Sector Lending?

The activities covered under Public sector lending are as follows:

Agriculture

• The lending to the agriculture sector includes Farm Credit (Agriculture and Allied
Activities), lending for Agriculture Infrastructure and Ancillary Activities.
• Farm Credit to Individual farmers including Self Help Groups (SHGs) or Joint Liability
Groups (JLGs) includes groups of individual farmers and Proprietorship firms of
farmers, directly engaged in Agriculture and Allied Activities, such as dairy, fishery,
animal husbandry, poultry, bee-keeping and sericulture.
• Crop loans include loans for traditional/non-traditional plantations, horticulture and
allied activities.
• Medium and long-term loans for agriculture and allied activities such as the purchase
of agricultural implements and machinery and developmental loans for allied activities.
• Loans for pre and post-harvest activities viz. spraying, harvesting, grading and
transporting their own farm produce.
• Loans to distressed farmers indebted to non-institutional lenders.
• Loans under the Kisan Credit Card Scheme.
• Loans to small and marginal farmers for purchase of land for agricultural purposes.
• Loans against pledge/hypothecation of agricultural produce (including warehouse
receipts) for a period not exceeding 12 months.
• The limit is fixed up to Rs.75 lakh against Negotiable Warehouse Receipts and up
to Rs. 50 lakh against warehouse receipts not coming under the above category.

57
• Loans to farmers for installation of stand-alone Solar Agriculture Pumps and
solarisation of grid-connected Agriculture Pumps.

Agricultural Infrastructure

• Loans for construction of storage facilities (warehouses, market yards, godowns and
silos) including the storage units/ cold storage chains designed to store agricultural
produce/products, irrespective of their location.
• Soil conservation and watershed development.

• Plant tissue culture and agri-biotechnology, seed production, production of bio-

pesticides, bio-fertilizer, and vermicomposting.

• For the above, the aggregate sanctioned limit of credit is Rs 100 crore per borrower
from the banking system.

Ancillary Activities

• Loans up to Rs 5 crore to co-operative societies of farmers for disposing of the produce

of members.
• Loans for setting up of Agriclinics and Agribusiness Centers.
• Loans for Food and Agro-processing up to an aggregate sanctioned limit of Rs 100
crore per borrower from the banking system.
• Bank loans to Primary Agricultural Credit Societies (PACS), Farmers’ Service
Societies (FSS) and Large-sized Adivasi Multi-Purpose Societies (LAMPS) for on-
lending to agriculture.
• Other eligible funds are with NABARD if a Public sector shortfall is noticed.

Small and Marginal Farmers

58
• Farmers with land holdings of up to 1 hectare come under the Marginal Farmer
category.
• Farmers with a landholding of more than 1 hectare and up to 2 hectares are considered
Small Farmers.
• Landless agricultural labourers, tenant farmers, oral lessees and share-croppers.
• Loans to Self Help Groups, where groups of individual Small and Marginal farmers are
directly engaged in Agriculture and Allied Activities.
• Banks have to maintain disaggregated data of such loans.
• Loans to farmers’ producer companies of individual farmers, and co-operatives of
farmers directly engaged in Agriculture and Allied Activities.
• In this case, the membership of Small and Marginal Farmers is not less than 75 per cent
and their land-holding share should not be less than 75 per cent of the total land-holding.

Micro, Small and Medium Enterprises (MSMEs)

• Micro enterprises are the ones where the investment in plant and machinery or
equipment does not exceed one crore rupees and turnover does not exceed five crore
rupees.
• Small enterprises are the ones where the investment in plant and machinery or
equipment does not exceed ten crore rupees and turnover does not exceed fifty crore
rupees.
• Medium enterprise, where the investment in plant and machinery or equipment does
not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore
rupees
• Bank loans to Micro, Small and Medium Enterprises, for both manufacturing and
service sectors are eligible to be classified under the Public sector as per the following-
• Manufacturing Enterprises
• Micro, Small and Medium Enterprises engaged in the manufacture or production of
goods to any industry specified in the first schedule to the Industries (Development and
Regulation) Act, 1951.
• They are notified by the Government from time to time, such industries are defined in
terms of investment in plant and machinery.

59
• Service Enterprises
• Bank loans up to Rs 5 crore per unit to Micro and Small Enterprises and Rs 10 crore to
Medium Enterprises engaged in providing or rendering services.
• They are defined in terms of investment in equipment under MSME Development Act,
2006.
• Khadi and Village Industries Sector
• All loans to units in this sector are eligible for classification under the sub-target of 7.5
per cent prescribed for Micro Enterprises under the Public sector.

Education

• Loans to individuals for educational purposes, including vocational courses, not

exceeding Rs 20 lakh are considered eligible for Public sector classification.
• Loans currently classified as a Public sector would continue till maturity.

Housing

• Loans to individuals up to Rs 35 lakh in metropolitan centres.

• Up to Rs 25 lakh in other areas apart from Urban centres for purchase/construction of
a dwelling unit per family.
• The overall cost of the dwelling unit in the metropolitan centre and at other centres
should not exceed Rs 45 lakh and Rs 30 lakh respectively.
• The housing loans to banks’ employees are excluded.
• Loans up to Rs10 lakh in metropolitan centres and up to Rs 6 lakh in other centres for
repairs to damaged dwelling units conforming to the overall cost of the dwelling unit.
• Bank loans to any governmental agency for construction of dwelling units or slum
clearance and rehabilitation of slum dwellers subject to dwelling units with a carpet
area of not more than 60 sq.m.

60
Social infrastructure

• Loans up to a limit of Rs 5 crore per borrower for setting up schools, drinking water
facilities and sanitation facilities.
• It includes the construction/ refurbishment of household toilets and water
improvements at the household level.
• Loans up to a limit of Rs 10 crore per borrower for building health care facilities
including under Ayushman Bharat in Tier-2 to Tier-6 centres
• In the case of UCBs, the above limits are applicable only in centres having a population
of less than one lakh.
• Bank credit to Micro Finance Institutions (MFI) extended for on-lending to individuals/
members of SHGs/ JLGs for water and sanitation facilities are also eligible under these
categories, subject to certain criteria.

Renewable Energy

• Loans up to Rs 30 crore to borrowers for purposes such as solar-based power

generators, biomass-based power generators, windmills, micro-hydel plants.
• Non-conventional renewable energy-based public utilities like street lighting systems
and remote village electrification.
• For individual households, the loan limit is Rs 10 lakh

Others

• Loans not exceeding Rs 1.00 lakh per borrower are provided directly by banks to
individuals and individual members of SHGs when they fulfill certain criteria of annual
income.
• Loans not exceeding Rs 2.00 lakh provided directly by banks to SHG for activities other
than agriculture or MSME, such as meeting social needs, construction or repair of
houses, construction of toilets or any viable common activity started by the SHGs.

61
• Loans to distressed persons not exceeding Rs 1,00,000/- per borrower to prepay their
debt to non-institutional lenders.
• Loans sanctioned to State Sponsored Organizations for Scheduled Castes/ Scheduled
Tribes for the specific purpose of purchase and supply of inputs and/or the marketing
of the outputs of the beneficiaries of these organizations.

Characteristics of Public, Private, and Foreign Banks (Group Aggregates)

Characteristic Public Sector Private Sector Foreign

Number of banks 26 20 40

Number of offices 69,498 (84 %) 13,408 (16%) 323 (0%)

Number of ATMs 77,684 (63%) 45,154 (36%) 1,234 (1%)

Number of employees 771,388 (76%) 214,304 (21%) 27,698 (3%)

Deposits (INR million) 50,020,134 11,745,874 2,770,634

(78%) (18%) (4%)

Advances (INR million) 38,783,125 9,664,182 2,298,486

(76%) (19%) (5%)

Assets (INR million) 60,379,816 16,778,013 5,862,186(7%)

(73%) (20%)

Investment (INR million) 15,040,764 5,259,822 2,004,884

(67%) (24%) (9%)

Public Sector Loans (INR 11,175,745 2,809,915 727,642(5%)

million) (76%) (19%)

Income (INR million) 5,350,980 1,584,781 472,207 (6%)

(72%) (21%)

Operating expenses (INR million) 902,145 (66%) 333,450 (24%) 135,438 (10%)

62
 Business per employee (INR 115.1 99.9 183.0
million)

Profit per employee (INR million) 0.6 1.1 3.4

Number of outstanding credit 3,589,135(19%) 10,235,409 4,977,602

cards (54%) (26%)

Amount of credit card 16,303(15%) 60,640 (54%) 34,804 (31%)

transactions (INR million)

PSL Performance by Bank Type

The RBI mandates that all SCBs – public, private and foreign banks - engage in PSL, but
the ability of banks to serve Public sectors varies with their business models. An analysis
of Public sector advances and ANBC for all categories of banks – public, private and
foreign, shows that in the past ten years (2000-01 to 2010-11) all categories of banks have
been successful in achieving their overall total PSL targets.34 35 It is only in 2012-13 that
the banks have not been able to meet the overall PSL targets: according to RBI data, as of
March 2013, Public sector advances made up 36.2 percent of advances by public sector
banks, 37.5 percent of advances by private sector banks, and 35.1 percent of advances by
foreign banks.

While overall targets have been met by all types of banks historically, all banks have, not
always been successful in achieving targets for sub sector lending to different Public
sectors. For example, public banks have been more successful than private banks in meeting
targets for agricultural lending. From 2000-01 to 2010-11, public banks achieved their
agricultural lending target eight times (64 percent) while private banks achieved the target
only six times (54 percent), a difference attributable to public banks’ extensive branch
networks in rural areas and their name recognition in rural markets.37 On the other hand,
foreign banks achieved export lending targets for all years from 2000-01 to2010-11,38 an
indicator of their global expertise in financing trade activities. With respect to lending to
MSEs as well, foreign banks met lending targets in all the years between 2000-01 and 2010-
11.

63
Differences in meeting PSL targets can be attributed to banks’ business objectives. While
one of the primary objectives of public banks is social welfare through bank penetration;
for private banks, it is to gain customers by providing value through new products and
advanced applications. Meanwhile, foreign banks strive to apply their global expertise to
world class products like trade financing, and introducing related banking products and
technologies in India.39 The distinct business models of the bank types are most evident in
three areas—expansion objectives, workforce composition, and performance indicators.

DIFFERENCES IN EXPANSION OBJECTIVES

Expansion goals can also be discerned by comparing extent of branch networks and asset
pools. India’s public sector banks have the largest share of branches and assets followed by
the private sector banks. A plausible reason behind this skewed branch network coverage
is the RBI directive that permits domestic SCBs to “open branches, administrative offices
and service branches in Tier 2 to Tier 6 centres (with population up to 99,999)… without
permission from RBI, subject to reporting.”40 Foreign banks on the other hand have to
abide by stringent regulations laid by the RBI’s Branch Authorization Policy and submit
their branch expansion plans on an annual basis. Thus, explaining the foreign banks’ 0.4
percent share in the country’s branch network.

However, besides the above regulatory aspect, the extent of a bank’s expansion is also
driven by its business objectives. In case of foreign banks, for instance, their objective and
expertise lies in servicing urban and HNI customers and providing corporate banking
services. Opening rural branches therefore is not a part of their business strategy. Thus,
while opening branches might not be an expansion objective of foreign banks, they attach
a high value to increasing their asset share in the country.

64
Share of Branches and Assets, by Bank Type

90.0% 83.0%
80.0% 72.8%
70.0%
60.0%
50.0%
40.0%
30.0% 20.2%
16.6%
20.0%
7.0%
10.0% 0.4%
0.0%
Public Sector Private Sector Foreign Banks
Share of Number of Branches Market Share of Assets

The growth in the number of branches of the public sector banks and their geographic
spread in the last decade also reflect their objective of serving the “unbanked” regions that
private and foreign sector banks have not yet entered (Figure 2-3).

Number of Branches of Public Sector Banks

80000
70000
60000
50000
40000
30000
20000
10000

Rural Semi-Urban Urban Metropolitan Total 0

65
The geographical spread of branches further indicates the kind of customers that banks
seek. About 93 percent of the branches in rural areas (population less than 10,000)41 belong
to public banks. In metropolitan areas (population 10 lakh and above) 78 percent of
branches belong to public banks, 21 percent to private banks, and 1 percent to foreign
banks. (Figure 2-44) Bank type wise spread of branches across rural, semi urban, urban and
metropolitan regions (Figures 2-5, 2-6 and 2-7) also reflects the skewed geographic
presence for each of bank type, with a diminishing trend observed in the number of rural
branches and an increasing trend observed in the number of metropolitan branches from

Regional Spread of Bank Branches

100% 93%
90%
79% 80% 77%
80%

70%

60%

50%

40%

30%
21% 20% 21%
20%

10% 7%
0% 0% 0% 1%
0%
Public Sector Private Sector Foreign Banks

Rural Semi-Urban Urban Metropolitan

Note: Data as of March 2012.

SOURCE: RBI.

66
 Regional Spread of Public Sector Banks Regional Spread of Private
Sector Banks

Rural,
Metropolitan, 12%
20% Metropolitan,
Rural, 27%
33%

Semi-
Urban, Urban,
21% Semi- 35%
Urban,
Urban, 26%
26%

DIFFERENCES IN WORKFORCE COMPOSITION

The difference in the business models of public, private, and foreign banks are also reflected
in their workforce composition. The type of skills, and therefore the staff that a bank recruits
largely depends on the customer base and services that the respective bank offers. For
instance, providing basic banking services to the masses is the primary objective of public
sector banks. To achieve this objective, public sector banks’ establish vast branch networks
in rural and semi-urban areas (population between 10,000 and 1 lakh) and hire staff well
versed in the local languages of the areas in order to serve clients. In contrast, foreign banks
specialize in servicing HNIs and focus their coverage to urban (population between 1 lakh
and 10 lakh) and metropolitan areas (population of 10 lakh and above) and recruit highly
paid staff from all over the country to concentrate on business development and expansion.
Thus, public sector banks are perceived as offering job security, while foreign banks—with
greater autonomy in recruitment and compensation—offer higher salaries.42 Mandating
PSL norms to cater to sectors like agriculture that is largely widespread in rural areas,
thereby imposes additional costs on foreign banks to recruit and manage two distinct types
of work force as the workforce hired to service HNIs cannot be trained to also deal with
rural PSL clients.

67
This could be inefficient and result in costly use of resources for the banks.

Figure 2-8 below demonstrates this difference in employee composition. As can be seen,
about 93 percent of the employees of foreign banks and 88 percent of those of private banks
are officers (senior most amongst the employee categories considered for analysis) while
41 percent of public bank employees are officers and approximately the same number are
clerks.

Employee Composition of Banks

100% 93%
88%
90%
80%
70%
60%
50% 41% 40%
40%
30%
19%
20%
9%
10% 5% 3%
2%
0%
Officers Clerks Sub Staff

Foreign Banks Private Sector Banks Public Sector Banks

SOURCE: RBI. Note: Data as of March 2012.

DIFFERENCES IN PERFORMANCE INDICATORS

Table 2-3 presents various indicators that shed more light on differences in performance
among the types of banks operating in India. Each indicator signifies a dimension of
banking risk and stability. For example, the net NPA ratio indicates the quality of a bank’s
assets because it includes assets that impose costs but do not generate income.

68
The capital to risk-weighted assets ratio (CRAR) measures a bank's financial strength. It is
computed as the ratio of its capital at hand (assets less liabilities) to its risk-weighted assets
like loans, cash, and investments.43 A bank with a higher CRAR is considered safer
because it can make up for bad loans with net assets. Currently, the RBI norm for CRAR
is 9 percent. Foreign banks’ high CRAR (16.8 percent) reflects high risk aversion and due
diligence practices that are relatively more conservative and stringent than those of private
banks (CRAR of 16.2 percent) and public banks (13.2 percent).

Indicators of Bank Performance

Foreign
Dimension Indicator Public Sector Private Sector
Sector

Soundness Capital to risk-weighted 13.2% 16.2% 16.8%

assets

Asset quality Net NPAs to total advances 1.5% 0.5% 0.6%

Profitability Return on assets 0.9% 1.5% 1.8%

Liquidity Liquid assets to total assets 7.9% 7.8% 5.7%

Efficiency Cost to income 16.9% 21.0% 28.7%

Asset Quality. The RBI defines a NPA as a credit facility with interest or principal
installments overdue for 90 days. Net NPAs are NPAs for which banks have made
provisions and thus indicate the actual burden of such assets.45 The lower the net NPA
ratio the better is the asset quality of the bank. The net NPA ratio is much lower for private
(0.5 percent) and foreign banks (0.6 percent), than public banks (1.5 percent), which is not
surprising given the vast scale of lending by public banks. Regression analysis supports this

69
indicator, revealing that public banks have the highest level of NPAs from PSL and foreign
banks the lowest (regression results are explained fully in Appendix C).

Profitability. Return on assets (ROA), the ratio of a bank’s net income to its total assets, is
a good indicator of profitability. The higher the ROA of the bank, the more efficiently the
asset base is being managed. The ROA of foreign banks (1.8 percent) is nearly twice that
of public banks (0.9 percent), indicative of the profit orientation of foreign banks.

Liquidity. The branch penetration and employee strength of public banks give them an edge
over private and foreign banks in liquidity and efficiency. The liquidity ratio indicates how
quickly a bank can liquidate assets and cover short-term liabilities. Liquid assets are defined
as cash on hand, the mandatory balances with the RBI, and balances in current accounts.46
The higher the liquidity ratio, the more easily a bank can cover its short-term debts. Public
banks have the highest liquidity ratio (7.9) percent, followed by private banks (7.8 percent)
and foreign banks (5.7 percent).

Efficiency. Efficiency is the ability of a bank to turn resources into revenue. The main
indicator is the ratio of operating cost to income. The lower the ratio the more efficient is
the bank in generating income. With the lowest efficiency ratio (16.9 percent), public banks
are much more efficient than private banks (21 percent) and foreign banks (28.7). One
plausible reason for this may be the difference in the ratio of wages to total expenses across
bank types; the ratio is highest for foreign banks (20.01) and lowest for public banks
(13.72). 47

The above parameters suggest that each type of bank has a business model that influences
branch expansion, customer base, workforce composition, and profit orientation. Foreign
and private banks outperform the public banks in profitability and asset quality, but public
banks are superior in liquidity and cost-effectiveness. Imposing uniform PSL targets on
banks is thus, an inefficient way to encourage them to apply their funding strengths for the

70
benefit of Public sectors, given the different business models of bank types and their
different abilities in servicing Public sectors. For the sake of efficiency, PSL norms should
be tailored to each bank type.

Impact of Public Sector Lending in India

To assess the impact of PSL in India, we compare the benefits of lending to three major
Public sectors—agriculture, exports, and micro and small enterprises (MSEs)—with the
costs borne by those lending to them. For each sector, we explore whether credit has
become more readily available and whether increased credit availability has improved
sector performance.

Benefits to Sectors

AGRICULTURE

Agriculture has been a Public in most of India’s social and economic policies since
independence. In 2011-12, it contributed around 16 percent to India’s GDP48 and 12.85
percent to exports,49 and employed about half the workforce. This sector’s growth,
however, faces a variety of challenges - from the vagaries of monsoons to the small size of
land holdings to a possible transition in the Indian economy from a purely agrarian to a
manufacturing and services based economy. This is demonstrated in the Figure 3-1 below,
that shows the diminishing share of agriculture in the total GDP from 1993-94 to 2012-13.

Share of Agricultural GDP in Total GDP (Current Prices)

71
The increase in the supply of formal credit to agriculture also indicates a shift in the sources
of financing for agriculture from non institutional money lenders to SCBs. In the 1950s,
noninstitutional credit, extended primarily by moneylenders, accounted for about 71.2
percent of the total agricultural credit, while commercial banks (including cooperative
banks and societies) accounted for only 3.9 percent.52 This trend had reversed in 2002,
with moneylenders providing 30.6 percent of agricultural credit and commercial banks
accounting for 51.8 percent credit to the sector. Formal institutions—SCBs, RRBs, and
cooperatives—now extend more than 60 percent of the credit (see Figure 3-3).53 In 2012-
13, SCBs accounted for about 71.2 percent of the formal credit to agriculture, followed by
cooperative banks at 18.3 percent and RRBs at 11 percent.54 RBI’s mandatory PSL
requirements have played an important role in increasing SCBs’ lending to agriculture
having increased at a CAGR of 25 percent from 2001-02 to 2011-12.55

These facts show that the credit supply to agriculture, PSL included, has increased. But the
increase does not seem to have improved the sector’s performance - productivity of the
sector has been stagnating when measured using agriculture value added per worker
(CAGR of 2 percent56 between 1980 and 2012) and has fallen when measured using the
ratio of Gross Capital Formation (GCF) to agricultural GDP (a proxy for capital
productivity) (CAGR of (- 2) percent between 1980-81 and 2007-08).57 Further, the asset
quality of the sector, measured in terms of NPAs in the sector, has deteriorated, with gross
NPA ratio58 increasing from 2.4 percent in March 2010 to 4.7 percent in March 2013. The
unsatisfactory performance of the sector vis-à-vis the credit lending also questions the
capacity of the sector to absorb formal credit to yield returns commensurate with the
increased credit supply. The fact that only 83 percent of RIDF’s funds have actually been
utilized as of 2013, also questions the ability of the sector to absorb more funds to improve
sector performance. 59 Thus, suggesting that other factors unique to the sector that keep
credit-related gains from being realized. Massive fragmentation of land holdings and the
close linkage that it has with the informal money market (as explained below) is an
important factor.

72
Agency Wise Formal Credit Flow to Agriculture

According to NABARD, small (less than 1.99 hectares) and marginal landholders (less than
1 hectare) account for as much as 85 percent of land holdings and 44 percent of cultivated
area.60 This extensive and increasing (Figure 3-4) fragmentation of land holdings has
serious consequences on various aspects of agricultural growth–production, storage,
transporting, marketing, incomes and formal credit outreach. Formal credit supply to small
and marginal owners of such lands is adversely affected largely because, “Banks find it
increasingly difficult to finance asset generating investments to small and marginal
borrowers, as they are not viable on marginal and small farms, unless they are also leased
out to neighboring farms.”61 This, along with farmers’ difficulty in satisfying banks’
collateral requirements, has farmers turning to informal moneylenders who are easily
accessible, impose no documentation requirements and provide timely credit. These money
lenders definitely meet the short term credit needs of these small farmers, however,
according to empirical studies, their unlawful practices - exorbitant interest rates (upto 180
percent) and unethical recovery practices, often trap the borrower in vicious debt
cycles.62Thus, these informal suppliers of agricultural credit not only add to the vagaries
of the agricultural borrowers but also make credit policies of the country less effective. To
highlight, only 14 percent of the marginal farmers (with land holdings less than 1 hectare)
were taking institutional credit in 2009, with the remaining largely relying on informal
sources of credit for their credit needs.

Number of Operational Farm Holdings by Size (hectares), 1970-71–2010-11

73
 Marginal, <1.00 Small, 1.00-1.99
Semi-Medium, 2.00-4.99

Medium, 4.00-9.99 Large,10.00 & above

The sector’s strong informal credit market, the increasing fragmentation of land holdings,
the inability of commercial banks to lend to small and marginal farmers and poor sector
performance thus indicate need for comprehensive review of the PSL scheme as well as an
independent study on the impact of Public lending for agriculture sector and also to find
innovative ways of increasing the outreach of credit to the sector, using channels other than
PSL. This is because despite there being a tremendous increase in the supply of PSL to the
sector (CAGR of 25 percent from 2001-02 to 2011-12), given the fragmentation of land
holdings, informal credit will have a role in agricultural lending for the foreseeable future.
To illustrate, in 1951, moneylenders and landlords extended 71.2 percent of credit; in 1991
they extended only 19.7 percent of credit. But in the following decade, they were the source
of 30.6 percent of agricultural credit, indicating a “reemergence of the rising, albeit
marginal, role of informal agencies in the provision of credit.”

74
In light of these factors, mandating banks to lend more to the sector under PSL guidelines,
might not solve the credit problems of the sector, with a large section of borrowers still
approaching the informal credit market. The need of the hour is to provide alternate sources

EXPORT SECTOR

That exports spur economic growth is well recognized. According to economic literature,
exports lead to improved productivity levels in the domestic economy due to diffusion of
knowledge about new techniques of production and management that in turn has a positive
influence on productivity of the non-export sector and the overall economy as well. 65 They
also lead to better allocation of resources driven by the requirements of specialization and
promote accumulation of foreign exchange that “enables the importation of capital and
intermediate inputs necessary in the production of goods exports.”

In the past decade, India achieved an average annual export growth of about 22 percent.
Excluding a slump in 2008–09, total exports have been increasing steadily (Figure 3-5).
After the global economic crisis of 2008, export growth slowed only to rebound in 2010-
12 due to various measures introduced by the government such as the Gold Card Scheme,
enhancement of the rupee export credit refinancing limit, and deregulation of interest rates
on export credit in foreign currency. However, exports began to fall again in 2012 because
of the continued decline in global demand.

Share of Total Export GDP in Total GDP (Current Prices), 1992-93 to 2012–13

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Prior to the 2012 guidelines on PSL, the RBI mandated all foreign banks, to lend a fixed
portion of their portfolios as export credit under Public sector lending. For domestic banks,
export was not a separate category - credit extended for exports in agriculture and MSE
sectors was categorized as credit to agriculture and MSEs respectively. With the revision
in the PSL norms, this mandate now applies only to foreign banks with less than 20
branches; for those having more than 20 branches the PSL norms are the same as that for
domestic banks. The categorization of the export sector as a Public sector is justified on
account of the fact that bank credit is a primary source of credit for the sector. Credit to the
export sector finances various activities of exporters, from researching the profitability of
new markets and making market-specific investments in capacity to achieving compliance
with regulations. It also helps exporters cover variable costs for shipping, duties, and freight
insurance that are incurred before revenue is realized.

Figure 3-6 summarizes trends in credit extended to exporters by SCBs. As noted earlier,
total export credit has been rising steadily, except during the financial crisis of 2008. PSL
has been an important contributor to this increased credit supply to exporters. Between
2001-02 and 2011-12, PSL grew at a CAGR of around 20 percent and contributed on
average 18 percent to export credit extended by

SCBs. The trend however reversed in 2012.

Before 2012, only foreign banks were required to lend 12 percent of their ANBC* to the
export sector because of their global presence in catering to the needs of the sector through
trade facilitating mechanisms like collection based payment. Since PSL guidelines were
revised in 2012, export credit ceased to exist as a separate category under Public sectors for
foreign banks with 20 or more branches (mainly Standard Chartered, HSBC, Citi Bank
India) just as in case of domestic banks. 73 This however would have a dampening effect
on the growth of India’s export sector, because of the aforementioned role that export credit,
and hence PSL plays in facilitating export activities.

In light of the current issues facing the Indian economy - falling exports, rising prices for
oil and coal imports,74 and the resultant increase in the trade deficit (5.4 percent of GDP

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during April-December 2012-13), India needs to strengthen and stimulate its export sector.
This in turn necessitates increasing credit supply to exporters. PSL has played a critical role
in stimulating exports. However, the revised guidelines—which require large foreign banks
(with over 20 branches) to direct credit to agriculture and excludes exports as a Public
sector for such banks—will dry up export credit to export oriented sectors, thereby
adversely impacting exports and the national GDP. India is facing a rising current account
deficit and an export-led growth strategy could help it reverse the trend; reducing credit
available to the export sector will only thwart this solution.

Costs of Public Sector Lending in India

Sector growth analysis has shed light on the direct and the indirect benefits of PSL. To fully
evaluate the impact, the costs of engaging in PSL must also be analyzed. This section
estimates the indirect and direct costs of PSL borne by the banking industry and the general
economy.

INDIRECT COSTS: NONPERFORMING ASSETS AND OPPORTUNITY COSTS

OF PSL

The RBI defines an NPA as a credit facility for which interest or installments of principal
are overdue by 90 days.88 Directed credit programs can lead to NPAs that affect the
banking industry, the flow of credit in the economy as a whole and general economic
growth.89 Banks raise money through deposits and by recycling

funds received from borrowers. When borrowers default, their loans become NPAs. Banks
therefore must retain a large portion of profits as a provision against bad loans, imposing
an opportunity cost on money that could otherwise be earning interest income.

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Directed lending narrows the choices of banks and makes loan repayment dependent on the
performance of particular sectors. To exemplify, while the growth rate of PSL credit
between 200203 and 2010-11 has been the highest in case of agriculture compared to export
and MSEs because of targeted lending norms, the growth rate of NPAs has also been the
highest for the sector, thus suggesting sector specific characteristics that influence the credit
absorption of the sector.

In 2011-12, PSL in India accounted for 45 percent of the SCBs’ NPAs. However, since
NPAs arise on account of both PSL and non PSL loans, we used regression analysis to test
the hypothesis that PSL loans impose a higher cost on the economy (in terms of Public
sector NPAs) compared to the non PSL loans. We performed two separate regressions,
using PSL loans and NPAs from PSL as the independent and the dependent variables in the
first regression and non PSL loans and non PSL NPAs in the second regression,
respectively. In other words, we tested the following two hypotheses:

NPAs (generated from Public sectors) = f (Public Sector Loans); and,

NPAs (generated from non Public sectors) = f (Non Public Sector Loans).

The regression analysis allowed us to assess the relationship among variables (positive or
negative) and also quantify the impact of that relationship.90 As described in Appendix C,
we found a statistically significant positive impact of loans on NPAs in both the regression
equations.91 We found that a 1 percent increase in PSL lending leads to a 0.22 percent
increase in NPAs in Public sectors. A 1 percent increase in the non-PSL loans, however,
leads to a 0.17 percent increase in NPAs in the non-PSL category. The difference in the
magnitude of impact indicates the greater cost that PSL loans impose on banks in the form
of NPAs vis-à-vis the non Public sectors.

Besides costs via the NPA channel, the PSL imposes indirect costs on the banking industry
(and also the economy) by penalizing banks for expanding their scale of lending. In other

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words, the principle of computation of a bank’s PSL target based on the previous year’s
ANBC* disincentivises banks to expand their current year’s scale of lending because of its
direct impact on the banks’ PSL target next year. As an example, if Bank ABC, has an
ANBC* of INR100 crores in year t, its PSL in year t+1 will be INR40 crores. Knowing that
increasing its ANBC* in year t+1 by 20 percent will automatically increase its PSL targets
for the year t+2 by 20 percent, might discourage banks to put efforts in increasing their
current year’s lending. This not only affects the profitability of the banking institutions, but
also reduces the optimal level of credit supply in the economy, thus imposing an
opportunity cost for non Public sectors of the economy, that are nevertheless crucial for
development.

To add to the above point, we take the case of infrastructure sector which plays a crucial
role in the development of the economy. After budgetary support and in the absence of a
developed corporate debt market, commercial banks are the major source of credit to
India’s infrastructure sector. Commercial banks, especially public sector banks, have
supported the infrastructural needs of the growing Indian economy, with bank credit to the
sector increasing at a CAGR of 38 percent over the last decade.92 It must however be noted
that banks have prudential exposure caps for infrastructure sector lending for individual
sectors, and these have been reached for some infrastructure sectors like power. Thus,
linking low valued high volume lending to sectors like agriculture, with ANBC which
includes infrastructure only contributes in reducing the pool of funds available for the
infrastructure sector, which is bound to grow as the economy grows.

Thus, although directed lending makes credit available to weak or struggling groups, its
indirect costs must be taken into consideration when evaluating its social benefits.

DIRECT COSTS

NPAs are an indirect measure of costs borne by banks in serving Public sectors. Direct
costs include funding, transaction, and credit costs. Funding cost is the marginal cost at
which banks are able to raise money. Transaction cost is the cost of delivering credit to the
borrower (e.g., wages, salaries, printing, rent, electricity, connectivity, transportation of

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cash, insurance, overhead, and depreciation). Credit cost is the sum of the risk and capital
cost of a loan:

Risk cost stems from the probability that a borrower will not repay a loan. The bank makes
provisions for “expected loan losses,” which are computed on the basis of the historical
creditworthiness of borrowers.

Capital cost stems from the probability of “unexpected losses.” Such losses are deviations
from average or expected losses, due perhaps to macroeconomic disturbances that require
a bank to set aside additional capital to cover deviations. Since these losses impose an
opportunity cost on bank funds, the bank must be given a premium on such losses in the
form of a threshold minimum return, called the hurdle rate. 95 96 Capital cost is thus
defined as

Capital Cost = Hurdle Rate * Unexpected Loss

We analyze the costs incurred by public, private and foreign banks in channeling small
amounts of credit to Public sectors like agriculture (domestic banks) and MSEs (foreign
banks) and compare these costs with the returns on such loans to determine the net
cost/return of PSL by bank type. In each category, the bank with the highest level of total
advances as of March 2012, is considered representative (i.e., the State Bank of India is
representative of public banks, ICICI of private banks, and Standard Chartered of foreign
banks).

The Table 3-1 below shows the total cost incurred and the returns obtained by different
bank categories in delivering credit to borrowers in the Public sectors. The table clearly
reflects that engaging in PSL generates high costs for the banks compared to the resulting
returns, which are low on account of interest rate ceilings imposed on these small loans. To
exemplify, for a loan of INR 10,000 offered by a public sector bank at 11.5 percent, the
bank makes a loss of INR 2,764. ((Cost – Return)* Loan size). The costs for private and
foreign banks are INR 1,272 and INR 1,172 respectively, thus indicating that irrespective

80
of the bank type, extending small size loans through branch networks is costly for the
banking industry.

Bank Wise Costs and Returns of PSL

Total

Cost of
Total
Bank Type Credit Return

Public Sector Banks 39.1% 11.5%

Private Sector Banks 26.7% 14%

Foreign Banks 25.7% 14%*

It is noteworthy to mention here that though the cost of delivering credit to borrowers is
highest for the public sector banks, some of these costs are absorbed or compensated by the
government, unlike in the case of the private and foreign sector banks. To substantiate,
according to former RBI governor, Dr.Duvvuri Subbarao, “[O]ver the last five years, the
government has infused INR477 billion in the public sector banks with an additional
amount of INR140 billion proposed to be invested during the current year (2013-14).”98
Though this capital infusion aims at meeting the enhanced capital needs of the public sector
banks under the Basel III requirements, it also shields the public sector banks from the risk
cost of credit resulting from high NPAs as described above. This highlights the reluctance
of banks, especially private and foreign banks to open up more branches and extend credit
to small borrowers covered under the Public sectors.

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This analysis shows that the cost of extending credit to Public sectors by expanding branch
networks is very costly for all types of banks relative to the interest income that such credit
generates. Interest rate ceilings for small loans, especially in case of agriculture limit the
banks’ ability to earn income on such loans in order to cover the “higher fixed costs and
higher perceived credit risk”99 associated with small loans. Further, since transaction costs
depend on the number of loans and not the loan size, a sum going to few borrowers costs
less than the same sum going to many borrowers. For Public sectors, especially agriculture,
loans are often small and the number of borrowers large, with consequently high transaction
costs. Thus, although PSL has made credit available to Public sectors the cost has been
onerous for banks. Banks should bear some costs in assisting the underprivileged but not
to the point of overwhelming their own viability. The analysis reinforces the fundamental
dilemma associated with Public sector lending in India mentioned by Dr Raghuram Rajan
in his report, A Hundred Small Steps: Report of the Committee on Financial Sector
Reforms.,

Reset PSL Targets by Bank Type

One size does not fit all when setting PSL targets. Public, private, and foreign banks must
be assigned targets that conform to their business models to ensure the efficiency of the
banking sector is not adversely affected.

Issue: Requiring all banks to lend 18 percent of PSL targets to agriculture is not an efficient
way to direct credit to agriculture. Public banks have advantages in lending to this sector.
They have a vast network of branches in rural areas and benefit from government support
schemes, like the Kisan Credit Card Scheme that gives a 2 percent per annum subsidy to
public banks for crop loans of up to INR 3 lakh to farmers.

Recommendation. Revise lending target for agriculture, based on the expertise and the
ability of different types of banks to service the sector. The agricultural lending target for
the banks should be structured on a descending scale for public and private banks taking
into account the branch network and their presence in rural and semi urban areas. Since
foreign banks do not have expertise in lending to the agricultural sector, they should not be

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required to lend to it, irrespective of their branch network. Instead, export credit, in which
they have global expertise, must be revitalized as a Public sector for foreign banks.

Recommendation: As with overall lending to agriculture, the ratio of direct and indirect
lending should be based on the ability of the bank to meet their targets. We recommend a
review of the direct and indirect agricultural lending targets for private banks relative to the
public banks. Further, we recommend review of these targets at a state level taking into
account the current presence of alternative funding agencies such as cooperatives and RRBs
in the respective states, in order to ensure an equitable distribution of access to credit. For
instance, the Southern states in India have a substantially higher share in agricultural credit,
largely on account of a strong cooperative movement there.

Issue: Foreign banks have neither the expertise nor the wherewithal to lend to the
agricultural sector. Foreign banks face an inherent disadvantage in extending credit to
India’s agricultural sector. The revised PSL guidelines that subject foreign banks with more
than 20 branches to the same lending requirements as domestic banks are not rational. To
meet those requirements, for example, banks will have to open more branches. The cost of
securing regulatory approval to establish new branches, coupled with the high opportunity
cost of lending to a less productive sector like agriculture, will discourage foreign banks
from expanding, especially banks close to the 20 branch threshold, like Deutsche Bank,
which had 18 branches as of March 2013. Foreign banks may also be dissuaded from
entering or remaining in branch banking in India. The United Bank of Switzerland, for
example, recently surrendered its banking license in India after reassessing its business
strategy.

Requiring foreign banks to meet agricultural lending targets is likely to have other adverse
consequences in a number of areas, including capital entering India in the form of
remittances, taxes paid by foreign banks, innovation in banking products and services, and
services for HNIs, multinational corporations, and Indian conglomerates that depend on
foreign banks for trade finance, cross-border transactions, and corporate servicing.

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Recommendation: Make other sectors Public sectors, at least for foreign banks. These could
include infrastructure, energy (especially renewable energy), healthcare, water supply, and
agriculture research and development. Loans to the energy sector, a “long gestation” sector,
might become productive assets for banks after three to four years but would be cheaper to
service because of lower transaction and customer acquisition costs. Likewise, sectors like
infrastructure, healthcare and energy are strategic in improving rural infrastructure, growth
in the agricultural sector and ultimately, the competitiveness of the Indian economy.

Provide Risk Cover to Agriculture and Make it More Attractive to Private Investors

Agriculture provides livelihoods for a vast portion of India’s population, but it continues to
be marred by the problems of stagnant/low productivity.105 A comparison of India with
six predominantly agrarian economies in Asia (Figure 4-1) reflects India’s poor
performance in terms of agriculture value added per worker, which the World Bank
considers as a measure of agricultural productivity.106 As can be seen in the figure below,
India fares better only compared to Philippines, with Indonesia coming almost at par with
India since 2009.

Cross Country Comparison of Agricultural Value Added per Worker

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In this backdrop of a stagnating agrarian economy, it is evident that provision of increased
credit supply is necessary, but not sufficient, to improve agricultural production in the
country. Providing risk cover to the sector and creating an enabling environment for the
sector to attract public and private investments at the grass-root level instead of increased
formal bank credit is the key to solving the sector’s productivity issues. Following are our
recommendations towards this end:

• Develop water, electricity, transport, and sanitation infrastructure in rural areas in order
to attract private investment into the sector.

• Develop a robust climate forecasting system that disseminates information at a grass

root level.

• Improve management and efficiency of irrigation projects in India. Creation and

maintenance of Operating and Maintenance (O&M) Funds for satisfying the financial
needs of irrigations projects, monitoring their progress and employing inter basin water
transfer for improving the irrigation potential is important.

• Strengthen government programs like the Minimum Support Price program and expand
its coverage in all states of the country by ensuring remunerative prices to farmers.

• Evolve agricultural insurance as a crucial risk intervention mechanism. Currently, the

primary agricultural insurance scheme operating in the country is the National
Agricultural Insurance Scheme implemented by the Agriculture Insurance Company of
India (AICIL) to “protect the farmers against losses suffered by them due to crop failure
on account of natural calamities”.109 While this program has played a crucial role in
risk mitigation, it suffers from limitations such as low indemnity levels, delays in claim
settlement, no coverage for horticultural crops and poor servicing.110 The role of the

85
 government in this process by introducing Credit Guarantee Schemes in the sector (like
the existing scheme in the MSE sector) is imperative. Additionally, the government
should encourage contract farming as an alternative risk management instrument and
attract private sector participation.

In addition to ensuring forward and backward linkages through marketing channels to

agricultural produce, contract farming has provisions for training cultivators, supplying
technology and inputs, and ensuring access to credit, as the contract itself serves as
collateral for banks.

• Agro-processing also holds promise for attracting investors. In 2010–2011, this

subsector was responsible for about 10 percent of India’s agricultural GDP and 8
percent of its manufacturing GDP; and between 2006-07 and 2010-11 employment in
the subsector grew at an average annual rate of about 4 percent.113 Agro-processing
attained Public sector status in 1999 but has been frequently reclassified, sometimes
under agriculture and sometimes under micro and small enterprises.114 In 2008, loans
for agro-processing were classified as indirect finance for agriculture; in 2012, they
were classified as direct finance for MSEs. Targets for agro-processing loans should be
classified under indirect targets for the agricultural sector. Banks usually meet PSL
lending targets for MSEs, so having agro-processing units in the same category means
the units are unlikely to get loans. In addition, the units are inherently aligned with
agriculture; channeling credit to them in that category will ensure that small farmers
benefit through backward linkages.

Use Innovative Market Driven Instruments to Make Credit Available to Public

Sectors, Ensuring Viability of Commercial Banks

While PSL norms were introduced primarily because of the failure of the market forces to
extend credit to certain economically weaker sections, the policy’s inability to satisfy the
credit demand of these sectors even after 40 years, indicates the need for reversion to market
forces to satisfy the credit needs of these sectors. Towards this end, we reiterate the
recommendations of the earlier committees on PSL in India, to issue Public Sector Lending

86
Certificates (PSLCs) to a registered lender (MFIs, Cooperatives, RRBs etc) who engages
in PSL and gets the PLSCs worth the amount of the PSL loans and allowing for trade of
these PLSCs. This would provide a platform that would enable deficient banks to purchase
these certificates to complete their PSL targets and sub targets and provide the lending
institutions with funds to sustain their financial viability. Unlike the InterBank Participation
Certificate Scheme which allows banks not able to meet their PSL targets to securitize loans
given by other institutions and include it in their targets, PLSCs are seen as a mechanism
to separate credit risk from refinancing where in the deficient banks can buy

certificates to compensate for their shortfall in lending. Thus, while the loans would
continue to be on the books of the original lender, and the deficient bank would only be
buying a right to undershoot its Public sector-lending requirement by the amount of the
certificate. This will allow the most efficient lenders to provide the credit to the needy
sectors with access to formal credit while not imposing the cost of the same on commercial
banks. A pilot to examine the positives and shortcomings of such a market driven PSL
program must be implemented.

Strengthen Cooperative Banks, Regional Rural Banks, and Microfinance Institutions

and Encourage Opening of “Small” Finance Banks

Directed credit programs can make credit available to Public sectors, but the costs are
unsustainable. Korea, Japan, and China established programs in the early stages of their
development, and then replaced them with government institutions that cater to Public
sectors. To ensure credit availability to these sectors in the long run, India needs sustainable
means for directing credit. Specialized institutions that focus on one or more of these
sectors while being embedded in general banking for their funding needs, will ensure both
viability of the lending institution and credit access to the needy. We recommend
strengthening the roles of such specialized lenders like cooperative banks and RRBs by
enhancing regulatory oversight, constructing an enabling environment for encouraging the
operations of microfinance institutions and encouraging small banks in rural and semi urban
areas that specialize in satisfying the small credit needs of Public sectors.

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COOPERATIVE BANKS

Because of their expansive outreach, India’s cooperative banks are increasingly supporting
small and marginal farmers. The cooperative banks’ share of credit for agricultural and
allied activities has fallen drastically, from 91 percent in 1970-71 to 17 percent in 2011-12,
but their share of the total number of loan accounts is substantial, an indicator of the small
size of loans. In 2011-12, cooperative banks provided credit to 3.09 crore farmers, whereas
commercial banks that accounted for 72 percent of the credit to the agricultural sector
provided credit to only 2.55 crore farmers.115 Even looking at how much was disbursed
for each account, cooperatives lent INR 28,467 in 2011-12, much less than RRBs (INR
66,000) or commercial banks (INR 1, 15,000).

The financial health of cooperatives has been weak, in part because of management and
governance problems.116 Ongoing revitalization of cooperatives through staff training,
corporate governance improvement, and organizational development is having some
positive impact (Table 4-1). Deposits held have fallen over the years, but loans outstanding
and net profits in 2011-12 were much improved over the previous year. NPA performance
has also improved. In light of these positive changes in the performance of cooperatives as
a result of the current reforms, and given their expansive outreach in the rural and semi
urban areas, cooperatives can be used as an effective means of servicing the small credit
needs of the large number marginal farmers in India

Performance Indicators: Cooperative Banks

Recovery NPAs to
Loans and
No. of
Net of Loans Loans
Advances
Years Banks Deposits Profit (%) Outstanding

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 (Outstanding)

2005- 1,113 135,286 150,480 633 62.4 26.2

2006

2006- 1,116 143,835 167,215 248 63.2 24.6

2007

2007- 1,118 168,602 181,828 -475 58.1 27.3

2008

2008- 1,118 200,880 175,354 1,860 61.0 25.6

2009

2009- 1,118 237,730 204,263 1,070 61.5 29.7

2010

2010- 1,118 252,000 228,600.39 892 60.3 23.1

2011

2011- 1,118 262,231 259,714.62 1,993 61.8 22.0

2012P

REGIONAL RURAL BANKS

RRBs have been providing credit to small and marginal farmers, agricultural laborers,
artisans, and small entrepreneurs since 1975. With 17,856 branches in 635 districts as of
March 2013, they are integral to India’s rural economy.117 RRB performance has been
modest because of the high cost of lending to the target groups, poor recovery of loans,
high staff costs, and lack of commercial orientation in management.118 The government is
restructuring RRBs so they can better serve the targeted population without incurring
inordinate losses. Restructuring includes training, introducing a common written exam for

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recruitment of officers, and strengthening the capital to risk-weighted assets ratios
(CRARs) by infusing up to INR 22 billion.119 Table 4-2 presents recent performance
indicators for RRBs. The fall in the number of RRBs is a function of recapitalization. Total
deposits declined for two consecutive years (2010-11 to 2011-12) then picked up in 2012-
13, indicating improved performance. The same held true for loans and advances and net
profits. In 2012-13, 63 of 64 RRBs made a profit of INR 2,384 crores, compared to 79 of
82 that made a profit of INR 1,886 crore in 2011-12.

Performance Indicators: RRBs

Loans and
Recovery NPAs to
No. of Advances
Net of Loans Loans
Years Banks Branches Deposits (Outstanding) Profit (%) Outstanding*

2004- 196 14,484 62,143 32,870 748 79.9 8.5

2005

2005- 133 14,494 71,329 39,713 617 79.8 7.3

2006

2006- 96 14,520 83,144 48,493 625 80.5 6.6

2007

2007- 91 14,761 99,093 58,984 1,328 80.8 6.1

2008

2008- 86 15,181 120,190 67,802 1,788 77.9 4.1

2009

2009- 82 15,444 145,035 82,819 2,542 80.1 3.7

2010

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 2010- 82 16,001 166,232 98,917 1,715 81.2 3.5
2011

2011- 82 16,909 186,336 116,385 1,857 81.6 5.0

2012

2012- 64 17,856 211,458 139,837 2,383 82.6 5.7

2013

MICROFINANCE INSTITUTIONS

Many things discourage formal banks and small borrowers from working together—
collateral requirements, loan approval processes, risk due to the seasonal nature of rural and
agricultural incomes, inadequate financial statements, and a general lack of tools for
assessing creditworthiness. In light of these obstacles, microfinance institutions (MFIs)
could significantly increase the credit supplied to unbanked rural and semi-urban areas
through their vast distribution network and business model of “last mile connectivity.” The
Public sector lending norms in India currently recognize bank credit to MFIs for lending to
farmers for agricultural and allied activities and to MSEs under the indirect finance
category in agriculture and MSE sector, respectively.

MFIs provide basic banking and insurance services to poor and low-income people. They
are close to borrowers and are aware of their credit requirements and ability to repay. Their
small-scale financial products and services, including loans (without collateral), insurance,
and transfer facilities, help the poor to smooth consumption, manage risk, and build
assets.122 Through self-help groups, MFIs are also effective in assisting poor women. And
because banks are their most common source of credit, MFIs advance the development of
the financial system by integrating formal credit with their own distribution networks.

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MFIs also have some shortcomings, the most serious being high interest rates. In fact, high
interest rates and coercive collection practices were alleged to be responsible for a surge in
suicide in rural Andhra Pradesh in 2010, to which the State government responded by
enacting the Andhra Pradesh Microfinance Institutions (Regulation of Money Lending)
Act.123 The act put in place stringent regulations regarding monthly repayments, requiring
registration of MFI branches, and banning door-to-door collection of repayments. MFI
repayment rates in the Andhra Pradesh have since fallen from 99 percent to less than 20
percent.

While the interest rates charged by MFIs are higher than that charged by banks, those
interest rates are a true reflection of supplying credit to rural customers. These rates are
what make the business sustainable when one factors in the very high transport, rent, and
personnel costs of administering a large number of small loans in rural areas.125 Reducing
travel costs by developing rural roads, educating borrowers on lending practices, making
rates transparent, and varying rates by region are all steps that could ensure rates reflect the
costs of administering credit while being high enough to make the business viable.

Despite the setback of the crisis in Andhra Pradesh, MFIs are getting stronger and
increasingly recognized as important to the financial inclusion of the weaker sections of the
population. To illustrate, the MFI borrower coverage went from - 27.3 percent in 2011-12
to 13 percent in 2012-13, an increase of 40 percentage points.

Cooperative banks, RRBs, and MFIs have the physical coverage and business models
necessary to extend credit to the smallest marginal borrowers in India’s rural areas.
Strengthening their roles will require regular monitoring of their progress and practices,
and of the funds flowing to them.

SMALL FINANCE BANKS

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Experience of countries like US, Philippines and other countries evidences success of small
sized local banks in increasing provision of financial services to the poor. Data for US
shows that small business enterprises that had strong local banking relationships, received
loans at lower rates, fewer collateral requirements, and enjoyed greater credit availability
than other small businesses.127 Being close to the borrower, these banks know about the
borrowers’ credit cycles and being small, the decision making power is vested in the loan
officer and loan disbursal simple compared to larger banks. They have low cost structures,
effective governance and management, and are thus better equipped to cater to small credit
needs of sectors like agriculture. While cooperatives, RRBs and MFIs are similar to such
small local banking institutions, having multiple small banks catering to such sectors, with
appropriate regulatory oversight can be used for ensuring timely access to small borrowers.

Promote enablers like an extensive credit information system to create a robust credit
infrastructure and a healthy credit culture

For the efficient functioning of the banking industry, infusing a healthy credit culture –
penalizing the defaulters and promoting repayment of loans- is of utmost importance. A
well functioning credit infrastructure facilitates this by allowing for widespread collection
and maintenance of information on borrower credit history, low cost pledging and
enforcement of collateral interests.129 Government initiatives like issuing Unique
Identification Numbers (UID) to over 60 crore residents of the country by 2014, is a step
towards creating a credit information system for the country. Further, the proposal to link
bank accounts with UID will not only benefit the creditors by increasing their chances of
repayment, but also the borrowers by increasing their access to formal bank credit. Public
private partnership can be used as an instrument to create an extensive system for tracking
individual information.

Quite often, certain government actions and regulations also add to the banks’ reluctance
to lend to some Public sectors. For instance, in 2008, a debt waiver scheme was announced
by the government of India that waived loans of about three crore small and marginal
farmers having land up to 2 hectare, giving partial relief to one crore more cultivators

93
having land more than 2 hectare. The INR 52,000 crore program was flawed in
implementation because of loan waiver favors extended to ineligible farmers, and
encouraging non-payment of dues by such small and marginal farmers in anticipation of a
debt waiver scheme in the near future. 130 Such programs are therefore onerous for the
banks and since the targeted beneficiaries, do not always benefit from such programs, their
net benefits for the overall economy are minimal.

Further, in case of MSEs, the Micro, Small and Medium Enterprises Act, 2006, makes
registration of micro or small enterprises with the District Industries Centre (DIC),131
optional, possibly a reason behind only 6 percent of the MSMEs being registered in the
country. 132 In the absence of formal registration and quite often, formal financial
reporting, banks are reluctant to lend credit to such small enterprises. Such government
actions must therefore be corrected in order to create an environment facilitating lending to
Public sectors by banks.

Use Technology to Reduce Cost of Credit Delivery

As aforementioned, the cost of delivering credit to Public sectors is high relative to the
returns that they generate, and is highest for public sector banks. Once the appropriate
infrastructure is in place, using technology through ATMSs, mobile and internet banking,
to deliver credit rather than branches would save costs for banking institutions. With the
telecom network in India evolving rapidly, mobile banking is the most promising
technology to facilitate access to credit especially in rural and remote areas.

Directed Credit—Forms, Effects, and Lessons

Governments in developed and developing economies use directed credit programs to

channel credit to sectors whose low returns and long gestation periods make them less
attractive to private investors, and to overcome “imperfections” in the free market

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operation of the banking system that make institutional credit hard to come by for such
sectors. These imperfections include asymmetric information about a borrower’s credit
history and the failure of financial institutions to recognize the social benefit of lending to
people who need credit but cannot readily comply with standard requirements for
acceptable collateral or financial statements. In theory, directed lending overcomes these
imperfections and provides fair and efficient credit to the sectors.

Forms of Directed Lending

Governments assume the responsibility of channeling and regulating credit flow to certain
sectors in order to promote industrialization and the growth of small industries, to
encourage the introduction of new agricultural production techniques, to achieve income
distribution objectives, and to house the poor. Directed credit programs take various
forms, including the following

• Mandatory lending requirements. Commercial banks are required to lend a certain

portion of their portfolio to specific sectors.

• Refinancing schemes. These schemes allow banks to borrow funds from the central
bank for specific use at a rate lower than what other banks would normally charge.

• Interest rate subsidies. Governments charge a below-market interest rate for a specific
line of credit and specify interest rate ceilings (on deposits or loans, or both), that might
vary by sector or loan term.

• Credit guarantees. Through guarantees, the lending institution bears part of the risk of
the loan.

• Development Financial Institutions. These specialized institutions provide specialized

credit.

• Of these forms, mandatory lending requirements are the most widely used.

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Positive and Negative Effects of Directed Lending

While advocates of directed lending say it does what market forces fail to do—lift up
weaker sectors—opponents say it diverts funds from productive sectors,5 imposes
economic costs in the form of loan losses and payment defaults, and imposes opportunity
costs of lending to non Public sectors of the economy.

Directed lending raises costs by way of loan losses, defaults, and payment delays which
results in an increase in commercial banks’ NPAs. An NPA is an asset that ceases to
generate any income for the lending bank. In directed lending programs, banks wield little
power in allocating credit, and must lend to sectors characterized by a relatively large
number of defaults due to factors specific to those sectors. Banks must then set aside
capital to account for assets that might be locked up in NPAs. This erodes banks’
profitability and makes them more vulnerable, as illustrated by the collapse of much of
the rural banking system in the Philippines.

Directed credit can also discourage deposit mobilization. This is because the subsidized
nature of loans under directed credit forces banks to pay even lower interest rates on
deposits, thus “taxing” depositors and transferring subsidies to borrowers. Low interest
rates also make deposits less attractive as a savings alternative.

In a capital scarce economy with less developed capital markets and with multiple
demands for credit from different sectors, quantitative targets based on the proportion of
gross advances also has a potential to crowd out lending for equally important sectors such
as infrastructure.

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Lessons from International Experience

Most countries direct credit for specific purposes. The rationale for directed credit
programs is that lending by the financial sector is not only a function of credit quality, risk
of tolerance and pricing of loans but also its influence and impact on social, geographic
and economic structures in the economy. Choice of sectors and financing options deployed
to direct lending to specific sectors/groups varies from country to country.

The experiences of Japan, Korea, China, Brazil, and Thailand suggest that directed credit
lending might not always be efficient in making financing available to certain sectors (see
Appendix A and Table 1-1). The experiences of Korea and Japan show how directed credit
can benefit industrial sectors, generate spillover effects, and contribute to general
economic growth. The experience of Brazil, where funds earmarked for small farmers
went to large and wealthy borrowers, reveals a weakness in directed credit programs. A
study conducted by the World Bank on the effectiveness of directed credit in the United
States suggests that directed credit policy had a limited impact and it might also be
negative when cross program effects are considered. The study shows that in US, the
directed credit programs have generally been successful in increasing credit to targeted
sectors, but not necessarily in increasing investment by such targeted groups.

In most countries, directed credit programs proved very costly, with the highest costs
borne by the banking industry. According to the Draft Technical Paper on the Review of
Public Sector Lending by RBI,

Furthermore, in case of the countries considered above, low repayment rates led to high
NPAs that locked up bank assets, affecting the banks’ profitability and efficiency. Non-
Public sectors also felt the impact of NPAs as funds available for lending dried up. Interest
rate ceilings under preferential credit policies led to an increase in borrowing in general,
contributing to inflation and price instability that, in turn, harmed the intended
beneficiaries of directed credit. In Korea and Japan, where directed credit was relatively
successful, the government closely monitored the programs, thus adding to the costs of
administering such programs.

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 Chapter 5
CONCLUSION AND SUGGESTIONS

CONCLUSION

The contribution of PSL in increasing the credit supply to Public sectors, primarily
agriculture, MSEs and export in India is clear. However, imposing mandatory PSL
restrictions on all types of SCBs uniformly, is not only an inefficient means of meeting
the needs of the sectors, but is also costly for the banks. Further, the responsiveness of
sectors to increase in PSL is governed by sector specific factors. Agriculture, in particular
is characterized by factors such as dependence on monsoons, stagnating / lowering
productivity, fragmentation of land holdings and the existence of an informal credit market
that throttles the impact of increased PSL from reaching the intended beneficiaries, and
contributing to the sector’s growth.

Thus looking at the costs incurred by banks in extending credit to Public sectors by
opening more branches, and in light of a strong informal credit market competing with the
formal credit due to comparative advantage of proximity to the borrower, we recommend
alternate channels of disbursing credit to these sectors specially agriculture. Resetting PSL
targets for banks based on their underlying business models will certainly enable them to
meet their targets efficiently. However, considering the costs of PSL for banks, credit
availability to Public sectors in the long run can be sustained by making these sectors,
especially agriculture, attractive for private sector investment and by strengthening
specialized financial institutions like RRBs, cooperatives and MFIs to meet the credit
needs of these Public sectors and stimulate positive feedback effect on the growth of these
sectors.

The scope and extent of Public sector lending has undergone a significant change in the
postreform period with several new areas and sectors being brought under its purview. A
drastic change in the Public sector lending seem to have happened with the setting up of

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an Internal Working Group under the chairmanship of shri.C.S.Murthy by RBI to examine
the need for continuance of Public sector lending prescriptions, review the existing policy,
130 targets and sub-targets and to recommend changes, required in this regard. The
lending activity towards Public sector by the entire selected research units are following
the norms for advances to Public sector on an average nearer one fourth to one third of
their total advances during the research period. It is suggested that bank have to increase
their lending activity towards Public sector to boost up the economy as Public sector is the
key segment of the development of the country.

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 SUGGESTIONS

1.Every bank should train a band of senior- and middle-level employees in the art of
lending to the Public sector, both agriculture and small-scale industry and they should
continue to be encouraged to upgrade their skills in the latest developments in this area of
lending.

2. Instead of making available Public-sector lending facilities in all branches, every bank
should set up specialised branches in all potential centres and extend Public-sector lending
through these branches alone where trained manpower should be deployed to facilitate
proper sanction and monitoring of these loans and advances.

3. The RBI should dispense with the present system of target-oriented lending to the
Public sector and banks should be given total freedom to lend to all deserving and
productive enterprises according to their own norms of lending without spoon-feeding the
banks in this regard.

4. The present system of allocating 40% of lendable resources to the Public sector by
every bank should not be insisted upon and all penal provisions for not achieving this level
of lending to the Public sector should be withdrawn with a view to give a free hand to the
banks to develop a portfolio of their choice in the interest of improving the asset quality
of every bank.

6. All subsidies now provided to banks for lending to certain Public sectors should be
withdrawn, and in its place, appropriate fiscal incentives should be provided so as to
minimise paperwork and misuse of the subsidy system.

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 CHAPTER 6

BIBLIOGRAPHY

References:-

1. Ahmed, J. U. D. (2010). Public sector lending by commercial banks in India: A case of

Barak Valley. Asian Journal of Finance & Accounting, 2(1), 92.

2. Dave, D. K. (2016). A Study of Public Sector Lending for Selected Public Sector Banks
of India. IJRAR-International Journal of Research and Analytical Reviews, 3

(3), 84-86. 3. Solanki, R. B. (2016, February). Public sector lending by commercial bank
in India: A study of selected public sector banks. Research Matrix, 62-66.

4. Uppal, R. K. (2009). Public sector advances: Trends, issues and strategies. Journal of
Accounting and Taxation, 1(5), 079-089.

5. Wikipedia contributors. (2019, July 28). Public sector lending.

6. https://www.rbi.org.in/scripts/banklinks.aspx

ANNUAL REPORT OF BANKS

1. Annual report of HDFC

2. Annual report of ICICI

3. Annual report of AXIS

4.Annual report of BOI

5.Annual report of BOB

6.Annual report of SBI

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