Is India’s unique floor and trade system on the verge of being subverted?
By regulations banks in India are required to make of 40% of their loans in the priority sector. The priority sector has sub-targets within this 40% target. Since 2016 a floor and trade system called Priority Sector Lending Certificates (much like carbon credits in a cap and trade system) helps promote efficiencies and specialization among banks while ensuring that the obligations of the banking sector as a whole towards the priority sector are fulfilled as intended by regulations.
The Priority Sector Lending Certificates (PSLCs) had a traded volume of INR 6.62 trillion (~US$ 80 billion at exchange rate prevailing on 17-May-2023) as per the Mint report cited later in this blog. The indirect influence of PSLCs on the Indian banking system is far greater given that it has either a direct or an indirect impact on 40% of India’s banking system.
Interestingly, there is no data on the PSLC prices since 2016! It is thought that gross NPA numbers in priority sector lending are typically very high (some informal estimates suggest this could be in the range of 20% – 30%—with a few exceptions like housing loans,…— even though the official numbers are much lower). The price for PSLCs needs to compensate the banks taking higher risks in lending to the priority sector and for incentivizing them to create a superior capacity to lend to this sector.
Now, Mint has reported (“Priority sector loan norms to get a rejig” by Subhash Narayan, 15-May-2023) that new norms could help banks with a shortfall in the priority sector lending targets by allowing them to make certain investments is specified bonds to cover the shortfall—something that’s been allowed in the past—and which ought to have been fully superseded by the PSLC system. Such a development will surely undermine the price signal in the PSLCs by artificially suppressing (manipulating?) the prices of PSLCs. On the contrary, fair prices for PSLCs will incentivize banks to create new capacities for superior lending to the priority sector. At fair price PSLCs can foster an environment for innovation in inclusive lending.
Which banks would gain with unviable low PSLC prices? Have the economists at banks with surplus PSLCs computed the risk-neutral prices of PSLCs? Wouldn’t the banks that stand to lose— from lower PSLC prices—want to have a more profitable priority sector lending portfolio? The silence of these banks is unfathomable!
Disclosure: The author of this blog first proposed the idea of Priority Sector Lending Certificates in his article “How to lend more to the poor” (Mint, 28-Mar-2007). He has called his idea “social credits”.
Aniruddha M Godbole is an inter-disciplinary expert. He is a continuous learner. These are his personal views.