Priority Sector Lending

Priority Sector Lending is an RBI-mandated scheme that requires banks to devote a certain portion of their lending to specific sectors considered important for the economy and under-served by the financial system. The goal is to ensure adequate credit flow to agriculture, weaker sections, and other priority sectors even if they may not be as immediately profitable as commercial loans, thereby promoting inclusive development. PSL sectors are: Agriculture, MSME, Export Credit, Education, Housing, Renewable Energy, Social Infrastructure, and Others. Each has eligibility criteria detailed by RBI.

PSL Targets and Sectors

For Scheduled Commercial Banks (SCBs) in India (including foreign banks with sizable presence), the overall PSL target is 40% of Adjusted Net Bank Credit (ANBC) (or Credit Equivalent of Off-Balance Sheet Exposure, whichever is higher). Regional Rural Banks and Small Finance Banks have a higher target of 75% of ANBC given their niche focus. Within the 40% total, there are sub-targets for certain categories for universal banks:

Agriculture

18% of ANBC should go to agriculture-related advances. Within this, a sub-target of 10% of ANBC is prescribed for Small and Marginal Farmers (SMFs). (SMFs are defined as farmers with landholding up to 2 hectares; earlier the target was phased in as 8% by 2017, now raised to 10% by recent revisions.) This ensures that a chunk of credit supports the most vulnerable farmers. Agricultural loans include those to individual farmers (for crops, equipment, etc.), farmer producer organizations, companies engaged in agriculture, etc.

Micro, Small and Medium Enterprises (MSMEs)

Within overall PSL, lending to MSMEs is a major category. There is a specific sub-target for Micro Enterprises: 7.5% of ANBC should go to micro enterprises (tiny units). This was implemented to uplift very small businesses. (There isn’t a separate sub-target for small/medium, but all MSME loans count toward PSL.) Notably, all bank loans to MSMEs qualify as priority sector (manufacturing or service, up to the investment/turnover limits of MSME definition). This includes loans to KVI (Khadi Village Industries) and start-ups in MSME domain too.

Weaker Sections

A category cutting across sectors, the target for Advances to Weaker Sections is 12% of ANBC. Weaker sections include small and marginal farmers, micro entrepreneurs, low-income groups, SC/ST borrowers, minority communities, SHGs, distressed persons, etc. (many of these loans are also counted in agriculture or MSME, but this sub-target ensures banks reach the really needy segments). RRBs have a 15% weaker section target.

Other Sectors under PSL

Apart from Agri and MSME, PSL includes:

• Export Credit – Loans to exporters for production of goods/services for export. For domestic banks, incremental export credit (over previous year) up to 2% of ANBC counts. (For foreign banks with <20 branches earlier, up to 32% could be export PSL, but RBI aligned foreign bank targets with domestic now.)
• Education – Education loans to individuals (for studies) up to a certain limit (₹20 lakh in India, ₹30 lakh abroad, as per latest Master Directions) qualify.
• Housing – Housing loans for certain categories: e.g., loans for affordable housing (defined as home loans up to ₹35 lakh for house value ≤ ₹45 lakh in metropolitan centers, and loans up to ₹25 lakh for house value ≤ ₹30 lakh in other centers) are priority. Also, loans for smaller housing projects, to housing finance companies for affordable housing, and home loans to weaker section borrowers count.
• Renewable Energy – Loans up to ₹30 crore to borrowers for solar, wind, biomass, etc. and up to ₹10 lakh for individual households for solar systems, etc., qualify as PSL (to encourage green energy).
• Social Infrastructure – e.g., loans up to ₹5 crore for building schools, healthcare facilities, sanitation, drinking water facilities in rural areas qualify.
• Others – This includes loans to State-sponsored organizations for SC/ST, loans to SHGs or Joint Liability Groups, loans to distressed persons (e.g. to prepay moneylender debt up to ₹1 lakh), and even personal loans to weaker sections in certain cases. Also, overdrafts up to ₹10,000 in PM Jan Dhan Yojana accounts count here.

Role of RIDF and Handling Shortfall

To enforce PSL targets, RBI monitors banks’ lending annually. If a bank fails to meet the targets/sub-targets, there are consequences. One key mechanism is the Rural Infrastructure Development Fund (RIDF) maintained by NABARD.

RIDF Contribution

Banks that shortfall in priority sector (or in agri sub-target, etc., as specified) are required to deposit the amount of shortfall with NABARD, in the RIDF. For example, if a bank was ₹100 crore short in agricultural lending, it will be asked to put ₹100 crore in RIDF for a specified tenure. These RIDF deposits earn a low interest (often much below market rates – deliberately to incentivize banks to lend directly rather than park money).

NABARD then uses the RIDF pool to finance rural infrastructure projects by state governments – things like irrigation, roads, bridges, electrification, water supply, etc. So, even if the bank didn’t lend to farmers directly, the money is still funneled into rural development through RIDF. Since RIDF’s start in 1995, large amounts have been deployed in rural projects. The idea is to not let priority sector shortfall money sit idle, but put it to use for development. RIDF is essentially a penalty mechanism but with a productive end-use.

Other Funds

In addition to RIDF for agriculture shortfall, there are similar funds for other categories, e.g., Shortfall in MSME lending may be directed to funds like TIF (Trade Infrastructure Fund) or others as decided. For foreign banks, earlier there was a requirement to contribute to SME Refinancing Funds of SIDBI for shortfall. Over time, RBI has merged some of these mechanisms. The Master Directions say all shortfall amounts will be allocated by RBI to one or more funds as needed – including RIDF, funds with NABARD, NHB (housing), SIDBI (MSME), MUDRA, etc.

Adjustments and PSL Certificates

RBI has also allowed trading of PSL Certificates – banks that exceed targets can sell surplus “priority credit” to banks that are short, for a fee. This market-based tool helps banks meet targets without necessarily contributing to RIDF. It’s an innovation to improve overall efficiency in achieving PSL.

Note: RIDF is managed by NABARD and funded by PSL-shortfall of banks. It’s used for rural infrastructure financing. Also know the 40% target and key sub-targets (18% agri with 10% SMF, 7.5% micro enterprises, 12% weaker sections).

PSL ensures credit to critical sectors and vulnerable groups. It has greatly expanded institutional credit in agriculture and small industries over decades, though banks sometimes argue about higher NPAs in priority sectors. Nonetheless, PSL remains a cornerstone of Indian banking policy for inclusive growth.