Directed lending: priority sector targets, PSLCs and co-lending

Detail

1. What directed lending means

• Directed lending means the RBI tells banks to send a fixed share of their loans to chosen sectors. The market does not decide these loans alone.
• NCERT says the RBI "sees that the banks give loans not just to profit-making businesses and traders but also to small cultivators, small scale industries, to small borrowers". This line describes priority sector lending (PSL).
• Why the RBI does this:
• Banks earn more from big, safe borrowers in cities.
• So without a rule, small farmers and tiny firms get few bank loans.

• They then turn to moneylenders and pay very high interest. This leads to debt traps, meaning people keep borrowing just to repay old debts.

• Social banking (1969 onwards) is the idea that banks should serve social goals, not only profit. PSL is its main tool.

2. History of PSL

• 1972: PSL was formalised, meaning the RBI laid down which sectors count as "priority".
• 1980: The Krishnaswamy Working Group set a target: 40% of bank credit should go to the priority sector by 1985.
• 2020: The RBI issued the PSL Master Directions of 4 September 2020 [2].
• 2025: The PSL Master Directions, 2025 replaced the 2020 rules. They came into force on 1 April 2025. The RBI last updated them on 11 September 2026 [2].

3. Key terms

• ANBC (Adjusted Net Bank Credit): a bank's total loans after some fixed adjustments. PSL targets are counted as a share of this number.
• CEOBE (Credit Equivalent of Off-Balance-Sheet Exposure): some promises a bank makes, such as guarantees, do not appear as loans on its balance sheet. CEOBE turns them into an equal loan amount.
• Rule: the PSL target is a share of ANBC or CEOBE, whichever is higher.

4. Current targets (PSL Directions 2025)

Category	Domestic commercial banks	RRBs	SFBs	UCBs
Total priority sector	40%	75%	60%	60%
Agriculture	18%	18%	18%	—
— of which small and marginal farmers (SMF)	10%	10%	10%	—
Micro enterprises	7.5%	7.5%	7.5%	7.5%
Weaker sections	12%	15%	12%	12%

Source for the full table: [2]. The domestic-bank column matches the scaffold.

• Regional Rural Banks (RRBs): they must lend 75% of ANBC to the priority sector. Their weaker-sections target is 15%, higher than the 12% for commercial banks [2].
• Small Finance Banks (SFBs): banks set up to serve small borrowers. Their target is now 60% of ANBC [2]. It used to be 75%. The 2019 Master Direction for SFBs set it at 75% [5] (NCERT: cut from 75% to 60% in 2025).
• Urban Co-operative Banks (UCBs): 60% [2].
• Foreign banks: 40% overall, whether they have 20 or more branches or fewer than 20 [2].

Worked example: a domestic bank with ANBC of ₹1,00,000 crore

• Total PSL = 40% → ₹40,000 crore
• Agriculture = 18% → ₹18,000 crore. Of this, SMF = 10% → ₹10,000 crore.
• Micro enterprises = 7.5% → ₹7,500 crore
• Weaker sections = 12% → ₹12,000 crore
• The sub-targets overlap. For example, a loan to a small farmer who is also from a weaker section counts under both. So the sub-targets do not simply add up to 40%.

5. Loan limits: what counts as PSL (2025 Directions)

• Education: up to ₹25 lakh per student [2].
• Housing: loan and property-cost limits depend on city size [2]:
• Cities with 50 lakh+ people: loan up to ₹50 lakh, house cost up to ₹63 lakh.
• Cities with 10–50 lakh people: loan up to ₹45 lakh, house cost up to ₹57 lakh.

• Smaller places: loan up to ₹35 lakh, house cost up to ₹44 lakh.

• Renewable energy: up to ₹35 crore, or ₹10 lakh for a single household [2].

• MSMEs: all bank loans to MSMEs count as PSL [2].
• Start-ups: loans up to ₹50 crore count as PSL [2].
• On-lending: a bank's loans to NBFCs and HFCs, which then lend to priority borrowers, can count as PSL. The cap is 5% of the bank's total PSL in the previous year [2].
• Service charges: banks cannot charge service fees on PSL loans up to ₹50,000 [2].

6. District weights: pushing credit to poorly served districts (FY 2024-25 to 2026-27)

• Per capita PSL means a district's total PSL credit divided by its population.
• Districts where this is below ₹9,000 (196 districts): new PSL loans there get a 125% weight [2].
• Districts where this is above ₹42,000 (198 districts): new PSL loans there get only a 90% weight [2].
• All other districts: 100% weight [2].
• Example: A bank gives ₹100 crore of new PSL loans in a low-credit district. It counts as ₹125 crore towards the target. The same ₹100 crore in a high-credit district counts as only ₹90 crore.
• Logic: this rewards banks for going to under-served regions, such as parts of the North-East and eastern India.

7. What happens when a bank falls short

• A bank that misses its target must put the shortfall into the RIDF (Rural Infrastructure Development Fund), run by NABARD. It may also have to put money into similar funds run by SIDBI (for small industry) and NHB (for housing). These deposits earn low returns.
• Interest the bank earns on RIDF deposits [2]:

Size of shortfall	Interest paid to the bank
Less than 5 percentage points	Bank Rate − 2%
5 to 10 percentage points	Bank Rate − 3%
10 percentage points or more	Bank Rate − 4%
Missed only a sub-target	Bank Rate − 2%

• Bank Rate is the rate at which the RBI lends to banks over a longer period.
• Worked example:
• A bank has ANBC of ₹1,00,000 crore and reaches only 36% PSL.
• Its shortfall is 4 percentage points, which is ₹4,000 crore.
• It must deposit ₹4,000 crore in RIDF at Bank Rate − 2%.

• That is well below what the money could earn as normal loans. So the rule works as a penalty.

• Monitoring: the RBI checks whether banks meet their targets every quarter [5].

8. Priority Sector Lending Certificates (PSLCs)

• Definition: a PSLC is a certificate that one bank can sell to another. A bank that lends more than its PSL target sells the surplus to a bank that is short.
• What moves and what does not:
• Only the "credit" for meeting the target moves to the buyer.
• No loan and no credit risk is transferred. The RBI says there is "no transfer of credit risk on the underlying as there is no transfer of tangible assets" [4].

• The original loan stays in the seller's books.

• Launched: RBI circular dated 7 April 2016 [4]. Trading takes place on the RBI's e-Kuber platform, which also settles the money [4].

• Who can trade: Scheduled Commercial Banks, RRBs, Local Area Banks, SFBs and UCBs that have made PSL-eligible loans [4].

The four types and what each counts towards [4]:

PSLC type	Counts towards
PSLC-Agriculture	Agriculture target + overall PSL target
PSLC-SF/MF	Small/marginal farmer sub-target + agriculture target + overall PSL target
PSLC-Micro Enterprises	Micro-enterprise sub-target + overall PSL target
PSLC-General	Overall PSL target only

Rules:

• Expiry: all PSLCs lapse on 31 March, the end of the financial year [4]. So they cannot be stored and used in later years.
• Price: the market decides the price. The buyer pays a fee (a premium) to the seller [4].
• Accounting: the buyer records the fee as an expense. The seller records it as miscellaneous income [4].
• Selling limit: a bank may sell PSLCs of up to 50% of its previous year's PSL achievement, even without extra loans in its books to back them [4].
• Lot size: ₹25 lakh and its multiples [2].

Worked example:

• An RRB lends ₹200 crore more to small farmers than its target requires.
• A foreign-owned bank is ₹200 crore short on its SMF sub-target.
• The RRB sells ₹200 crore of PSLC-SF/MF to the foreign-owned bank at a 1.5% premium.
• The RRB earns ₹3 crore of income.
• The foreign-owned bank meets its sub-target. It pays ₹3 crore instead of putting ₹200 crore into RIDF at a low return.

Why PSLCs exist:

• They reward lenders with rural reach, such as RRBs and SFBs, for going beyond their targets.
• Banks with little rural presence pay a fee instead.
• Overall, the system meets its targets at a lower cost. Banks that lend to rural borrowers most cheaply do more of that lending.

9. Co-lending

• Definition: in co-lending, two regulated lenders jointly fund a loan in an agreed ratio. Usually these are a bank and an NBFC (Non-Banking Financial Company, a lender that is not a bank).
• Why it helps:
• Banks have low-cost funds, because deposits are cheap for them.
• NBFCs have last-mile reach, meaning local agents and knowledge of small borrowers.
• Co-lending puts the two strengths together.

How it developed:

• 2018: co-origination scheme, in which banks and NBFCs jointly created priority sector loans.
• November 2020: the Co-Lending Model (CLM) for priority sector loans. The NBFC had to keep at least 20% of each loan.
• 6 August 2025: the RBI issued the Co-Lending Arrangements Directions, 2025. They apply from 1 January 2026, or earlier if a lender's own policy allows [3].

Main rules of the 2025 Directions [3]:

• Who is covered: commercial banks, all-India financial institutions and NBFCs, including housing finance companies. SFBs, Local Area Banks and RRBs are not covered.
• Loan types: co-lending is no longer limited to priority sector loans. A co-lent loan can be counted as PSL only if it meets the PSL rules.
• Minimum share: each partner must keep at least 10% of every loan (NCERT: 10%, extended to all regulated entities and loan types; under the 2020 CLM the NBFC kept at least 20%).
• Blended interest rate: the borrower pays one rate. It is the average of the two lenders' rates, weighted by each lender's share of the funding.
• Formula: Blended rate = (Share₁ × Rate₁) + (Share₂ × Rate₂)

• Example: a bank funds 80% of a loan at 9% and an NBFC funds 20% at 14%. Blended rate = 0.8 × 9 + 0.2 × 14 = 7.2 + 2.8 = 10%.

• Default Loss Guarantee (DLG): one partner may promise to cover the other's losses if the borrower does not repay. This promise is capped at 5% of loans outstanding.

• Escrow account: all payouts and repayments must go through an escrow account, a bank account that neither partner controls alone.
• Timing: each partner's share must appear in its books within 15 calendar days of payout.
• Asset classification works at the borrower level:
• Suppose one partner marks the loan as SMA (Special Mention Account, an early warning of stress) or NPA (Non-Performing Asset, a loan not being repaid).
• Then the other partner must mark it the same way.

• So neither partner can hide a bad loan.

• Disclosure: partners must list their active co-lending partners on their websites. They must also report loan amounts, rates, fees and loan performance in their financial statements.

• Detailed regulatory rules are covered in the banking-regulation-npas note.

Prelims Hooks

• Krishnaswamy Working Group (1980) → set a 40% PSL target to be reached by 1985. PSL was formalised in 1972.
• PSL target for domestic banks = 40% of ANBC or CEOBE, whichever is higher. Agriculture 18%, of which SMF 10%. Micro 7.5%. Weaker sections 12%.
• RRBs 75%. SFBs 60% (earlier 75%). UCBs 60%. The RRB weaker-sections target is 15%, not 12%.
• PSLCs: launched April 2016 and traded on e-Kuber. No transfer of loans or credit risk. All PSLCs expire on 31 March.
• PSLC-SF/MF is the only type that counts towards three targets: SMF, agriculture and overall. PSLC-General counts only towards the overall target.
• Trap: the PSLC fee is market-determined, not fixed by the RBI. The buyer books it as an expense and the seller as miscellaneous income.
• Trap: the RIDF is run by NABARD, not SIDBI. Shortfall deposits earn Bank Rate minus 2 to 4%, depending on the size of the shortfall.
• District weights (FY25–FY27): new PSL loans in districts with per capita PSL below ₹9,000 get a 125% weight. In districts above ₹42,000, they get a 90% weight.
• Co-lending Directions 2025: each partner keeps at least 10%. The DLG cap is 5%. They apply from 1 January 2026. SFBs, RRBs and LABs are excluded.
• 2020 Co-Lending Model: the NBFC kept at least 20%, and the model covered priority sector loans only.

Mains Points

• Directed credit vs. efficient credit:
• PSL sends credit to farmers and micro firms that the market ignores.
• But forced lending can lower loan quality and bank profits.

• PSLCs and district weights are "market-friendly" fixes. They keep the social goal but let the cheapest lender do the lending.

• PSLCs as a reward for rural reach:

• RRBs and SFBs earn fee income for lending beyond their targets.
• Banks that are weak in rural areas pay a fee instead of parking money in RIDF at low returns.

• Risk: a bank can "buy" compliance without ever lending to a single farmer. This weakens the direct link between banks and rural borrowers.

• Co-lending as a bridge between banks and NBFCs:

• It combines banks' low-cost funds with the NBFCs' last-mile reach and so extends formal credit to thin-file borrowers.
• The 10% minimum share and the borrower-level NPA rule keep each partner's own money at stake.

• Escrow accounts and disclosures protect borrowers. This links to the goals of PMJDY and the financial inclusion agenda (GS-III: inclusive growth).

• Regional equity:

• Credit gathers in a few states and districts.
• District-level weights are a direct policy tool against regional imbalance. They link to Aspirational Districts and balanced regional development.