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Bank credit: two sectors cry for attention

The Reserve Bank of India’s theme-based report, Currency and Finance, has been released ahead of its schedule and soon after its Annual Report 2007-08. Past reports have covered topics such as Evolution of monetary policy (2003-04), Evolution of central banking in India (2004-05) and Development of financial markets and the role of the central bank (2005-06).

The latest report has its theme “The banking sector in India: emerging issues and challenges” and covers the period 2006-08. It covers a wide range of contemporary issues in banking, drawing from history as well as recent experiences.

Like the previous reports, this one too will be a reference manual for years to come.

The chapter on lending and investment operations of banks, dealing with the nuts and bolts as it were, will be of perennial interest. Within that, lending to agriculture and small and medium enterprises (SMEs) is highly topical.

Despite strong policy support, these two sectors are not getting their due share of bank credit. As on March 31, 2007, as a proportion of total credit, agriculture got 12 per cent and SMEs a measly four per cent.

Against these, industry received a 38 per cent share and personal loans (for consumer durables and home loans) 22 per cent. The last category personal loans have become popular fairly recently. At the start of the reform period in 1992, they claimed just eight per cent of the total credit. Agriculture’s share then was 15 per cent and industry’s 48 per cent.

In proportionate terms, agriculture and industry are receiving less credit. But by far steeper declines are seen in the shares of agriculture and SMEs. In 1992, their shares were 15 per cent and 12 per cent, respectively.

An obvious inference is that banks and institutions have found the emerging category of retail loans more attractive and probably safer. It is also certain that thanks to disintermediation sections of industry are able to raise resources from non-banking channels, notably the capital market. A fall in proportionate share, however, does not mean that in absolute terms too agriculture is getting less. In 2007, scheduled commercial banks had outstandings of Rs.160,000 crore by way of direct credit and a larger Rs.190,000 crore by way of indirect credit. In 2001, commercial banks lent slightly over Rs. 42,000 crore under each of these two categories.

Another way of measuring the flow of credit to agriculture is through comparing credit intensity which is the percentage of agricultural credit to agricultural GDP. This has increased sharply from 11.3 per cent in 200-01 to 31 per cent in 2006-07.

The following are some of the outstanding issues in agricultural credit delivery:

(a) A change in demand pattern as the agricultural sector is getting diversified requiring a higher level of finance.

(b) Although there is still a preponderance of small and marginal farmers, there is a move towards input based commercial farming. At present banks are geared more to financing traditional crops such as cereals and have to reorient themselves to face the challenges of commercialisation of farming. Among others, there is a need to work out new risk assessment systems, delivery channels and, even more basically, new forms of assessing credit needs.

(c) The banking system will have to face the problem of ‘financial dualism’ characterised by a faster development of urban financial markets as compared to their rural counterparts. A related issue is the digital divide between urban and rural areas.

While explaining the SMEs’ small share in total credit disbursements, the RBI report points out that in the absence of a common definition of what constitutes a small or medium enterprise, different banks have interpreted differently. Consequently, data collection has suffered. The anomaly has since been corrected with the passage in 2006 of the Micro, Small and Medium Enterprises Development (MSMED) Act.

However, low bank lending to the sector cannot be attributed to definition problems alone. Credit disbursements both as a percentage of credit to industry and percentage of total credit declined sharply during 1996-2007. The SME share in non-food credit declined from 15.1 per cent in end March 1991 to 6.5 per cent in 2007. As is to be expected, private banks and foreign banks rank lower than the PSBs in this regard.

There are several reasons for this. Risk-averse bankers have tended to stay away from SME enterprises, as lending to them is considered less safe than to large companies. Even where they are able to access loans, SMEs and the large companies are not on the same footing. It is well established that in the days of deregulation, large companies are able to strike a better bargain with the PSBs than SMEs. Further impediments arise in the form of business organisation most SMEs have — sole proprietorship or partnership. As a rule they have limited credit history. Information about them is less easily available. Very few are listed on stock exchanges.

A crucial step in improving credit delivery to the SME sector is to improve the banking system’s capabilities in assessing the credit requirements. Small scale should not be equated with high risk. A number of policy measures have been taken. With the passage of the MSMED Act distortions that create perverse incentives for firms to remain small have been removed. SME can now be encouraged to grow and reap economies of scale. The Credit Information Companies (Regulation) Act, 2005, has strengthened the legal mechanism for information collection and dissemination. A debt restructuring mechanism including a one time settlement for SME accounts has helped some units. Much more, of course, needs to be done in the area of institutional credit to agriculture and SMEs.

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