RBI allows Priority Sector tag to loans from Banks to NBFCs

The Reserve Bank of India has allowed for the continuance of lending by scheduled commercial banks (SCBs) to non-banking finance companies (NBFCs) for the purpose of ‘on-lending’ to priority sector loan (PSL) segments on an on-going basis.

• Loans to microfinance institutions (MFIs) by small finance banks (SFB) will also continue to be tagged as PSL loans on an on-going basis.

• The facility of lending by commercial banks to NBFCs and lending by Small Finance Banks (SFBs) to NBFC-MFIs, for the purpose of on-lending to certain priority sectors, was available till March 31, 2022.
• Now, the Reserve Bank of India (RBI) permitted banks, including small finance banks, to continue providing credit facility to NBFCs for the purpose of on-lending to certain priority sectors.
• Bank credit to NBFCs, including HFCs, for on-lending will be allowed up to an overall limit of 5 per cent of an individual bank's total priority sector lending in the case of commercial banks.
• In the case of SFBs, credit to NBFC-MFIs (Non-Banking Financial Company - Micro Finance Institutions) and other MFIs (Societies, Trusts, etc) which are members of RBI recognised 'Self-Regulatory Organisation' of the sector, will be allowed up to an overall limit of 10 per cent of an individual bank's total priority sector lending.
• These limits will be computed by averaging across four quarters of the financial year, to determine adherence to the prescribed cap.
• According to the circular, SFBs are allowed to lend to registered NBFC-MFIs and other MFIs which have a Gross Loan Portfolio (GLP) of up to Rs 500 crore as on March 31 of the previous financial year, for the purpose of on-lending to priority sectors.

What is Priority Sector Lending?

• PSL refers to mandatory lending by banks to economically weaker sections. 
• The idea behind this is to ensure that adequate institutional credit reaches some of the rather vulnerable sectors of the economy, which otherwise may not be attractive for banks from the profitability point of view.
• Priority Sectors: PS includes eight identified sectors.

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

The existing guidelines for PSL

• Commercial Banks: Commercial banks have to lend at least 40 percent of their loan to PSL category.
• Small Finance Banks: SFBs are required to extend 75 percent of its Adjusted Net Bank Credit (ANBC) to the sectors eligible for classification as PSL by the Reserve Bank.
• Under existing guidelines, bank loans up to a limit of Rs 150 million for purposes like solar power generators, biomass power generators, wind mills, micro-hydel plants and for non-conventional energy based public utilities like street lighting systems and remote village electrification are currently eligible to be classified under priority sector loans under the ‘Renewable Energy’.
• For individual households, the loan limit is Rs. 1 million per borrower.

What is ‘on lending’?

• In literal terms, on-lending refers to giving loans to somebody by the use of borrowed money.
• In India, the RBI has promoted on-lending by banks to the NBFCs for providing loans to certain sectors. Here, the banks give funds to the NBFCs and the latter deliver the loans to the ultimate weaker section beneficiary.
• Effectively, under the programme, NBFCs can make on-lending to the priority sector beneficiaries by using bank’s funds under the Priority Sector Lending programme.

The decision of RBI to continue the scheme is a welcome step as it will improve the flow of credit to the unserved and underserved sector of the economy and make available funds to the ultimate beneficiary at an affordable cost, considering the lower cost of funds from banks and greater reach of the NBFCs.