Tuesday, January 12, 2016

Why there may be a need to tone down priority sector lending: Economic Times 16th December 2015

Jan-Dhan, small banks, payments banks, MUDRA Bank, new private banks are all efforts to enhance financial inclusion. The bifocal vision is on garnering deposits and enhancing lending to segments which come under ‘priority sector’. This is the social aspect of banking.

The other side to banking is the commercial motivation where banks strive to deliver higher returns to shareholders which can be the government for PSBs and various institutions and individuals for private banks. Curiously, while banks have to perforce ensure that 40 per cent of lending is to the priority sector, this segment has also been vulnerable to shocks leading to a build-up of NPAs.

The table below provides an overview of the spread of NPAs across four broad sectors for FY15 for 6 new private banks (ICICI, HDFC, Axis, Kotak, IndusInd and Yes Bank) and top 10 public sector banks in terms of the size of advances (SBI, BOB, PNB, Canara, Bank of India, IDBI, Syndicate, Central Bank, Indian Overseas Bank and Union).

payments-banks

The table shows that new private banks perform quite differently from PSBs. Their NPAs were 1.31 per cent in the priority segment while PSBs had a ratio of 6.38 per cent. Within this set, these banks had an even dispersion of priority sector advances to agriculture and industry which accounted for around 50 per cent while the balance was in services and personal loans where the incidence of NPAs was lower. For PSBs around 62 per cent of the priority sector advances portfolio was in agriculture and industry which had higher delinquency rates.

The higher delinquency rates for agriculture and industry within priority sector lending was due to their vulnerability to adversities. A slowdown in industry affects the small units the most of which face diminishing growth in sales, high cost of credit, receivables and inventories with NPAs being 8.95 per cent (10.64 per cent for PSBs) across all sectors. In case of agriculture, a poor monsoon implies higher NPAs which were 6.02 per cent for PSBs.

Within the non-priority classification, too, the PSBs had higher NPA ratios. The PSBs had 58 per cent of their exposure to industry, followed by 25 per cent to services and 17 per cent in personal loans.

In case of the new private banks the ratios were 40 per cent, 33 per cent and 27 per cent, respectively. Once again the PSBs have been saddled with more of their advances going into the industrial sector — infra and vulnerable sectors such as textiles, steel, mining, aviation and power.

Private banks have played smarter by diversifying into services and personal segments, where NPA propensity is lower. This has kept the overall NPA levels low at just about 2 per cent, while PSBs have had a ratio of 4.4 per cent in this segment.

What are the takeaways here? First, priority sector lending is not the ideal avenue for banks as it pops up higher NPAs given the vulnerability of the segments.

Second, if this is the possible outcome, new entrants into banking especially on the financial inclusion side, like the small and new private banks, have to examine and explore the issues relating to priority sector lending with dexterity to ensure that their books remain clean from the start.

Third, within the non-priority sector, the NPAs in industry reflect to a large extent the risks involved in lending to the infra sector where the private banks have limited their exposures.

Fourth, a large part of this funding requirement has to shift to the corporate debt market. Companies perforce should be asked to borrow a certain part of their requirements, say 20 per cent to begin with, from this market as the PSBs cannot bear the burden of supporting growth in infra and manufacturing where the risk is high.

Fifth, the PSBs would also need to probably pursue the strategies of the private banks in keeping NPAs lower and focus on services and personal loans segment.

The government on its part would also have to review the sanctity of the 40 per cent level. While the weaker sections have to be supported, banks may not be the ideal medium as it weakens the genetic design of the system. Curiously, in our context, we expect the government to prop up economic activity, which should be done by the private sector and also simultaneously want banks to do social good, which though laudable, weakens its structure.

Ironically after doing so, asset quality and capital issues relating to PSBs come back to haunt the government!

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