Why Housing Sector Falls Under Priority Sector Lending
Amartya Sen once said: “Economic growth without investment in human development is unsustainable and unethical.”
There are certain sectors in the economy that require a regular inflow of credit in the larger interest of the country. As part of their role in the development of India, commercial banks extend a committed proportion of their adjusted net credit as loans to these sectors, which are classified as priority sectors. This is called priority-sector lending (PSL).
In 1972, after the National Credit Council highlighted that there should be larger participation of commercial banks in the priority sector, PSL was properly defined. The overall objective of PSL is to initiate enough credit and flow of funds into some of the sensitive sectors like agriculture finance, micro, small and medium enterprises (MSMEs), retail credit and housing. Banks may not find these sectors the most attractive from a profit-making point of view, but they provide a specific portion of their net credit as PSL, under guidelines from the Reserve Bank of India (RBI), for overall growth of the country at large.
Housing as a priority sector
An important part of PSL for banks is the housing sector. While possessing a house is a dream for most people, many are not able to realise their dream due to difficulties in availing of mortgage. To help such people, new home ownership schemes are kept under the purview of PSL.
Banks' PSL targets for housing
An RBI circular, PSL: Target and Classification, dated May 10, 2016, underlines that loans of up to Rs 28 lakh in metropolitan cities and up to Rs 20 lakh in other cities for purchase or construction of a dwelling unit should be considered as PSL, provided the overall cost of the dwelling unit does not exceed Rs 35 lakh in metros and Rs 25 lakh in other cities.
According to RBI guidelines, domestic and foreign banks with 20 or more branches are required to extend at least 40 per cent of their adjusted net credit as PSL, while those with fewer than 20 branches need to maintain PSL of 32 per cent.
Housing loans under PSL are provided for three purposes – construction of a house, repair of an existing house, and clearance of slums or rehabilitation projects. Home loans for repair of damaged properties fall under PSL only if they are of up to Rs 5 lakh in metros and Rs 2 lakh at other centres.
RBI has allowed a loan-to-value (LTV) ratio of up to 90 per cent for home loans of up to Rs 30 lakh – those of up to Rs 28 lakh in metros and Rs 20 lakh in other cities are PSL. Earlier, a 90 per cent LTV was allowed on loans of up to Rs 20 lakh.
What if banks fail to meet the PSL target?
According to data from the department of financial services, priority sector lending by State Bank of India was 17 per cent of PSL by all public-sector banks as of March 2015. SBI was followed by Punjab National Bank, with 7.98 per cent, and Canara Bank (6.95 per cent).
The banks that fail to meet the PSL target are instructed to invest the shortfall amount in bonds of National Bank for Agriculture and Rural Development (Nabard) or Rural Infrastructure Development Fund (RIDF), where returns are as low as three per cent. This is done to hedge the lending risk.
Striking a Balance
The provision for PSL depends on how much loans banks extend to the priority sectors. Banks take adequate steps to meet the target. In case of a shortfall, they sometimes show off-balance sheet items like derivative instruments to show their PSL accomplishments. However, this does not further the government's cause.
The shortfall happens because banks find it difficult to lend to some priority sectors, given that the rate of default in those sectors is high. If the borrower defaults on repayment, the bank's stress increases; sometimes, these loans even become non-performing assets. Therefore, it is might help meet the objective better if an effective framework is developed to create a database of potential and creditworthy borrowers who can be funded under PSL.