Banks in any country are the backbone of the economy. Primary role of banks is to cater the demand of funds from various communities. RBI has made it mandatory for banks to lend at least 40% of their credit to select sectors i.e. weaker sections which impact a larger chunk of population. Below is the list of sectors:
- SSI (Small Scale Industries) – Artisans, Cottage Industries
- Small Business – (Defined in RBIs publication)
- Housing – (Loan for less than 15L)
- Education Loan – (covers 10L for India and 20L for abroad)
- Micro Credit – (Akin microfinance. up to 50k/entity)
Not only on a consolidated basis but RBI has also decided for sub targets. For example Bank ABC gets a deposit of Rs.150 and after complying with mandatory requirement they plan to lend Rs.100. Out of this Rs.100 they will have to lend at least Rs.40 to the aforesaid sectors. Banks while lending to the above sectors will have to fulfill individual target as well. At least 18 %( Rs.18 in our example) should be lent for agricultural activities. At least 10% (Rs.10 in our example) should be for the weaker sections and so on. Ratios differ for domestic and foreign banks. For Foreign banks total priority sector lending target is kept at 32% of total credit. For foreign banks at least 10% (Rs.10 in our example) should be SSI and so on.
Banks need to comply with 40 %/(32% foreign banks) by the end of the financial year. Since this check is done in March end, banks keeps the PRL ratio low for major part of the year and rush for the same in the last few months. Banks are the key investors in securitized products having underlying credit from any of the above sectors. A microfinance company normally charges ~26-28% for a loan. After they have completed their capital (lending borrowers) they package those assets and sell the securitized asset to banks with a yield of ~10-14%. Banks happily apply for it even at 10% given this investment also complies with RBI’s PRL requirement. (Note banks consider rating of the asset before buying ht same)
What if Banks fails to comply with this requirement?
Banks have to make up for the balance and deposit it with institutions as asked by RBI. Let’s continue with our example. If bank fails to lend Rs.40 and instead offers only Rs.35 by march end towards PRL then bank is mandated to invest the balance with rural infrastructure development fund (RIDF). RIDF is a government organization operated by NABARD and funds projects related to rural roads, irrigation, flood protection and related rural activities.
What will be the return offered by RIDF?
This depends on the quantum by which bank failed to keep up its mandated requirement. In our example bank’s shortfall was at 5% (Rs.40-Rs.35) and so it will be paid bank rate less 2%. See below
Foreign banks need to lend the shortfall to Small Enterprise Development Fund (SEDF) which is managed by SIDBI.
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