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Priority Sector Lending (PSL) Norms for Small Finance Banks: RBI’s Recent Relaxation

27.06.2025

 

Priority Sector Lending (PSL) Norms for Small Finance Banks: RBI’s Recent Relaxation

 

Context:
 In June 2025, the Reserve Bank of India (RBI) relaxed priority sector lending (PSL) requirements for Small Finance Banks (SFBs). This step aims to offer greater operational flexibility to SFBs while maintaining the focus on inclusive credit to underserved sectors.

 

About the News:

  • RBI relaxed PSL target for SFBs from 75% to 60%.
     This reduces the compulsory lending burden for SFBs.
  • Change effective from FY 2025–26.
     It applies to all existing and upcoming SFBs.
  • Additional 20% allocation can be flexible.
     Banks may lend to sectors of their own expertise.
  • Objective is to balance regulation and business viability.
     It allows SFBs to manage risk while serving the priority sector.

 

Key Characteristics of the Reform:

  • PSL includes loans to vital under-served sectors.
     E.g., agriculture, MSMEs, education, renewable energy, weaker sections.
  • New target is 60% of ANBC (adjusted net bank credit) or CEOBE (credit equivalent of off-balance sheet exposures, Whichever is higher will be considered.
  • 40% of credit must follow standard PSL rules.
     It must be spread across sub-sectors like MSME, housing, etc.
  • Remaining 20% is flexible.
    SFBs can allocate it to sectors where they have expertise.
  • Aligns with earlier PSL reforms (March 2025).
    At that time, limits for cooperative banks and loan categories like housing and education were also adjusted.
  • Encourages innovation in credit delivery.
     Especially through technology-led and low-cost banking models.
     

About SFB (Small Financial Banks)

 

  • Financial Inclusion Focus
    SFBs provide banking and credit services to underserved groups like small businesses, farmers, and low-income households.
  • RBI Regulation
    SFBs are regulated by RBI and follow all prudential norms like CRR, SLR, and capital adequacy requirements.
  • Eligibility Criteria
    Resident individuals, NBFCs, MFIs, and cooperative banks with sound credentials can apply under RBI’s on-tap licensing scheme.
  • Lending Mandate
    75% credit must go to priority sectors; 50% of loans should be under ₹25 lakh to aid small borrowers.
  • Branch and Capital Norms
     Minimum capital of ₹200 crore; 25% of branches must be in unbanked rural areas to expand financial access.

 

About Cooperative Banks
 

  • Definition and Classification
    Cooperative banks are member-owned institutions registered under state or central cooperative laws, categorized as Urban Cooperative Banks and Rural Cooperative Banks.
  • Ownership and Voting Rights
    They are owned by their customers, who are also members, with equal voting rights under the principle of “one person, one vote.”
  • Objective and Functions
    Their main aim is to provide credit to farmers, small businesses, and self-employed workers, especially in rural and semi-urban areas.
  • Regulatory Framework
    They are regulated jointly by RBI for banking functions and by the Registrar of Cooperative Societies for governance and management.
  • Role in Financial Inclusion
    Cooperative banks support inclusive growth by reaching unbanked sections and remained stable during crises like the 2008 global financial crisis.

 

Challenges:

  • Reduced PSL target may dilute social focus.
     E.g., fewer loans may reach farmers or small borrowers.
  • Concentration in profitable sectors may rise.
     E.g., SFBs may prefer housing over agriculture.
  • Monitoring flexible 20% allocation can be tricky.
     E.g., misuse in non-priority lending disguised as PSL.
  • Risk of urban shift in SFB lending pattern.
     E.g., loans may favour urban MSMEs over rural enterprises.
     

Way Forward:

  • Ensure transparency in 20% flexible allocation.
     E.g., RBI can publish sectoral lending data.
  • Strengthen auditing and compliance systems.
     E.g., annual reports should detail PSL lending.
  • Incentivize lending to neglected sectors.
     E.g., provide interest subvention for agriculture loans.
  • Promote digital credit models for outreach.
     E.g., use mobile banking for rural and unbanked regions.

 

Conclusion:
The RBI’s revision of PSL norms for Small Finance Banks reflects an effort to balance regulatory goals with business realities. While this move provides flexibility and competitiveness, the real test lies in maintaining inclusivity and financial outreach to the most vulnerable and under-banked sectors of the economy. Continuous oversight and innovative credit practices will be essential to fulfill the original intent of the PSL policy.

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