7.01 There are certain issues which over time have become a part of policy but on which there is clearly need for a fresh examination as to whether such systems and policies have led to overall efficiency of the system. The Committee believes that these issues need to be addressed and have therefore suggested certain policy changes which will facilitate the increased flow of agricultural credit.

Interest Rates

7.02 The overall structure of interest rates has been simplified and deregulated and presently the prescriptions on lending rates in respect of commercial banks apply to loans below Rs.2 lac. The rates of interest as applicable to co-operative banks and regional rural banks have already been deregulated. Co-operative banks and Regional Rural Banks have adjusted interest rates taking note of local factors and are generally pricing their loans below Rs.2 lac at a level higher than commercial banks. During our field visits, and in discussion with farmers at various levels, it was mentioned that what was more important was the timely sanction of a credit limit and rates of interest were of secondary importance. It was argued that even the revised rates charged by co-operatives and RRBs were much below those charged by the private money lenders whose role, even in agriculturally advanced states such as Punjab, is substantial , particularly for loans of short duration.

7.03 From the viewpoint of banks, the regulated rates of interest operate as a barrier to the sanction of small loans as managers tend to look for comparatively larger borrowers. This is one of the reasons why the share of commercial banks in crop production loans is substantially smaller than that of the co-operatives. The Committee is convinced that for crop loans there is a substantial unfulfilled demand which is being met either by the money lender or leading to the usage of lower inputs causing a loss of income to the farmer in both situations.

7.04 Viability of lending for agriculture depends on a number of factors such as appropriate volumes, acceptable levels of recovery and a margin to cover cost of funds as well as expenses in sanctioning, supervising and recovery of loans. Staff costs per unit for small loans are higher as compared to large loans and would need to be appropriately priced. Commercial banks are doing so presently through cross subsidisation of rates of interest, which implies that an extra loading of interest cost is being given to loans above Rs.2 lac. Typically, rates of interest in banks vary from 12% for the lowest segment to over 19% at the upper end. It is our view that such cross subsidisation is not an efficient form of fixing interest rates. Commercial banks should, therefore, be free to fix their rates for loans of all amounts as has already been done in the case of co-operative banks and RRBs.

Subsidy linked Credit

7.05 It is well accepted that over the years the Indian banking system has significantly achieved the goals of extending geographical reach and functional spread of banking services. However, as pointed out by the Committee on the Financial System, this progress has exacted a heavy toll in the form of a decline in productivity and efficiency of the system and, in consequence, a serious erosion of its profitability - even to the point of raising doubts about the viability of some important constituents of the system.

7.06 During its field visits, it was repeatedly submitted by banks that they were increasingly uncomfortable with sanctioning loans under the subsidy linked programmes. It was pointed out that such programmes have constricted operational flexibility, depressed income potential, blurred the distinction between credit need and credit worthiness, given a go-by to recoveries and had a psychologically negative impact on the self-image of field level bankers.

7.07 It was pointed out that the agricultural credit portfolios of commercial banks comprise two sets of borrowers û one linked to Government Subsidy Schemes where cases are sponsored by Government agencies and sanctioned by banks and the other identified by banks directly. Recoveries in respect of the former are around 30%, while those in respect of the latter are 80% plus. The loans sanctioned under the subsidy linked schemes tend to contaminate the overall asset portfolio, restrict fresh lending and impede the flow of fresh credit in areas having large arrears. The Committee is of the view that the scope to further extend credit in sectors such as agriculture, small industry and the self-employed is substantial provided this is done on the basis of the commercial decision of banks.

7.08 District level Government officials expressed similar views regarding the implementation of credit-linked subsidy schemes. It was submitted that the emphasis of such schemes was on the achievement of physical targets and that, in implementing the disaggregated district-wise targets handed down to them, they were conforming to systemic requirements. They added that since the impact of such schemes in bringing families above the poverty line or providing gainful employment was weak, there was a need for an overall review of the whole system.

7.09 The issues raised by commercial banks in context of credit linked Government sponsored schemes raises the question as to whether the system of subsidy driven credit, which has been the principal instrument for reaching the poor, can be replaced by one where subsidies and credit exist side by side but flow through separate channels and target different segments of the rural poor and, if so, the conditions necessary for such an arrangement.

7.10 The Committee believes that such an arrangement is possible. In its view, rural borrowers who have experience in dealing with assets û financial or physical û can be targetted directly by commercial banks. Even those at the lowest rung of the poverty pyramid requiring assets and start-up support can be financed by banks through NGO/SHG intermediation coupled with expanded micro credit working capital facilities to the non-farm sector. The role of the government should be to utilise the subsidy accessed through the budgetary mechanism for improving infrastructural facilities, providing linkages, upgrading the quality of extension services and providing training to those identified for the purpose. The Committee is clear that the poor are bankable and that there is adequate experience in India as well as internationally to suggest that lending even to the poorest can be done profitably and on a large scale given certain preconditions such as customer sensitive loan products, appraisal of projects consistent with assessment of borrowers, full discretion in selection thereof, reinstatement of collateral requirements, improved methods of working, better follow-up and diligent tracking of overdue accounts. If this is done, there is no reason for banks not being able to lead development and increase access of credit to the poor consistent with productivity.

Target for Agricultural Lending

7.11 During its discussions with State Governments as well as others, the Committee frequently came across a criticism that despite initiatives taken to accelerate the flow of credit to the agricultural sector, commercial banks continue to fall short of meeting the target for agricultural lending fixed at 18% of net bank credit.

7.12 The Committee notes that net bank credit of public sector banks grew at an annual compound rate of 11.8% between March 1991 and March 1996. Agricultural credit grew at a compound rate of 10.7%, while credit to medium and large industry grew by 15.9% in the same period. In the real sector, GDP grew on an average by 4.8%, industrial production by 6.1% and agricultural production by 2.1%. The target of 18% lending to agriculture was fixed at a time when the reserve requirements were as high as 63%. These have progressively been reduced over the years and are now at 39%. Total lendable resources of banks have thus increased from 37% to 61% over the last five years. In absolute terms, lendable resources based on effective reserve requirements increased from Rs.113080 crore in 1992 to Rs.270536 crore in 1996 and net bank credit increased from Rs.117443 crore to Rs.228583 crore in the same period. In other words, since the base on which the target of 18% is calculated `doubled' requiring banks to concomitantly double their lendings to agriculture to even maintain the same share, i.e. 16% in conditions where agricultural production itself was growing at 2.1% per annum . Although agricultural lending of public sector banks increased from Rs.15857 crore in 1991 to Rs.26351 Crore in 1996, the share of such advances to net bank credit actually declined from 15.0% in 1991 to 14.3% in 1996.

7.13 The targets for priority sector as well as for agricultural credit are fixed on the basis of `outstandings' and drawing conclusions on the flow of credit to agriculture on this basis can be somewhat misleading since outstandings decrease as a result of improved recoveries as was the case between 1990 and 1995 during which period recoveries improved from 48.8% to 59.5%. Outstanding credit also decreases when write-offs take place. Thus, under the ARDRS 1990-91, public sector banks provided Rs.2832 crore as debt relief of which around Rs.1900 crore was for agriculture. The combined effect of improved recovery and write-offs was to reduce the share of lending to agriculture without any deceleration in the pace of lending to the sector.

In view of the above, the Committee suggests that banks should have self set targets for lending to agriculture which should be based on the flow of credit. For this, banks need to prepare special agricultural credit plans, the objective of which would be to accelerate the flow as well as to substantially improve the quality of lending in terms of viability. The Reserve Bank of India would indicate annually the expected increase in the flow of credit over the previous years on the basis of which banks would prepare appropriate credit plans. Once such a system is in place, the 18% target currently based on outstandings would cease to have much relevance.

Service Area Approach

7.14 The Service Area Approach (SAA) was recommended at a Seminar on Rural Banking organised by the Reserve Bank in January 1988 to deliberate on the findings of field studies undertaken by public sector banks in the previous year. The studies indicated that while bank credit had increased in rural areas, both in terms of outreach and aggregate flows, its impact on agricultural production and rural income was becoming weak. The quality of bank lending was uneven, its coverage scattered and not based on a schematic or intensive area development approach. It was, therefore, felt that the time was opportune to move over to a system under which bank branches would concentrate their attention on specified areas.

7.15 The Committee discussed the efficacy of the SAA with banks, Government officials and borrowers and received a mixed response. A section of the respondents submitted that the SAA is an anachronism surviving by default rather than design and that in an environment increasingly characterised by the interplay of market forces, it is an impediment to borrowers and banks alike. Certain others were of the view that the basic assumption underlying the approach that branches of all banks are uniformly endowed in terms of resources, capabilities, infrastructure and staff, was empirically untenable. It was also submitted that the mechanical application of the parameters of village allocations had seriously impaired the infrastructure and human resource capabilities of banks such as the SBI, Bank of Baroda, etc. which had earlier adopted the intensive area development approach for rural development and set up special branches for the purpose manned by expert staff and supported by requisite infrastructure. On the other hand, those advocating the retention of the SAA pointed out the need for all villages to have access to at least one branch for its credit needs. The SAA, by demarcating areas and making branches accountable for providing credit to all categories of borrowers in the allotted villages has given the poor at least one bank branch to service their requirements together with a mechanism by which accountability can be determined.

7.16 After considering the various arguments, the Committee is broadly in favour of a substantial modification of the service area approach so as to provide the borrower a choice of banks as well as to the banker a larger area of operation. The following changes are recommended:

1. The Committee proposes that borrowers should be free to approach any branch of a commercial bank for credit and it would be for the commercial bank to determine whether or not to do business with the borrower, based on its assessment of the latter's credit-worthiness.
   
2. Banks should also be free to operate outside their service area. This would be of particular interest to some banks, such as State Bank of India, which have set up well-staffed agriculture development branches; some of which, on account of service area limitations, are not utilising their potential.
3. The responsibility of a particular bank for the credit requirements of a particular village should continue to be made in such a manner that every village is linked to a bank branch for its credit needs. In respect of such villages, a particular designated service area branch will continue to assume responsibility for requirements of borrowers.
4. Presently, any modification in service area requires the approval of the Reserve Bank of India. Subject to the limitation envisaged in para (c) above, it is suggested that any changes which may need to be made should be decided through mutual consultations amongst banks at a local level. Intimation of such changes should thereafter be sent to the Reserve Bank of India as well as others concerned.