Impact of Priority Sector Advances on Profitability of Public Sector Banks in India

What the paper says

IntroductionSince bank nationalisation in 1969, the commercial banks in India have been charged with the responsibility of providing investible funds to the weaker and hitherto neglected segments of the society. Not only the branch expansion policy but the lending policy was also completely revamped and the credit allocation by banks to priority sectors* of the economy has received a boost and public sector banks have performed well in meeting these targets and sub-targets. Initially, the proportion of credit to priority sector was fixed at 33.3 per cent, which was raised to 40 per cent in 1980. In fact, credit outstanding of priority sector had reached 49.20 per cent in 1986 and remained around that level during the entire eighties. However, in recent times, the bank authorities are seriously concerned about the declining profitability of the public sector banks. It had been argued by a band of economists and researchers that the various credit and developmental policies of the Reserve Bank of India and the Government of India, have increased the quantum of interest subsidised loans causing heavy interest income losses; caused higher establishment expenditure to supervise small accounts without matching productivity; raised the level of credit outstanding of sick units; resulted in the poor recovery of small loans; and expanded the volume of non-performing assets, etc., in turn have plunged the profits and profitability of public sector banks (PCBs).The Report of the Committee to Review the Working of the Monetary System (1985) headed by Sukhamoy Chakravarty has observed that,the banks provided loans to specified sectors at relatively low or at concessional interest rates some of which are lower than their cost of funds.It is noticed that more than 90 per cent of the bank's total earnings are by way of interest on loans and advances and the subsidised interest rate and preferential terms of lending without compensation has affected their earnings as well as profitability to a greater extent.The Financial sector Reforms Committee headed by Narasimham focussed its attention on the profitability of banks and pointed out that,increasing trends in directed credit programmes and increasing non-performing assets, etc., have seriously affected the profitability of banks.The Committee also recommended that priority sector credit to net bank credit should be reduced to 10 per cent from 40 per cent. Therefore, this paper attempts to examine the broad and often repeated observations of the economists, bankers and researchers that the priority sector advances have actually eroded the profits of the public sector banks. The recommendations and suggestions made by the Narasimham Committee on priority sector is also empirically analysed.PreludeThe bankers and economists have conducted various studies to identify the factors affecting the profits and profitability of Public sector Banks and have identified that the policy statements and Guidelines of the Reserve Bank of India and the Government of India comprising SLR, CRR, higher volume of non-performing assets, credit to priority sectors, etc., are responsible for the low profitability of the public sector banks in India. It is observed that most of the studies examined this issue hypothetically without much empirical testing.The only study in recent years which has analysed more comprehensively the impact of priority sector advances on profitability of Public sector Banks was by Dr. T. R. Bishnoi1. According to him, as a result of simultaneous increase in interest subsidy and outstanding credit for priority sector since 1974, the computed interest income loss for Public sector Banks have increased from Rs.33.44 crores in 1974 to Rs. 607.39 crores in 1986.On the other hand, Agarwal2, Murugesan and Chandrasehkara Rao3 and Elavia and BansaP have derived that neither the ratio of priority sector credit outstanding to total advance nor the proportion of rural branches to total branches had significant adverse impact on bank profits. …