RBI Revises Priority Sector Lending Norms for Small Finance Banks from FY 2025-26

The Reserve Bank of India (RBI) has announced a key revision in the Priority Sector Lending (PSL) norms for Small Finance Banks (SFBs), set to take effect from the financial year 2025-26. These changes are aimed at enhancing credit efficiency, promoting targeted lending, and aligning SFB operations with the evolving financial inclusion landscape.

The revised provisions mark a significant update to the existing guidelines for licensing SFBs, originally issued on November 27, 2014, and further expanded in the ‘on-tap’ licensing guidelines dated December 5, 2019.

Current PSL Norms for SFBs

As per Paragraph II (9) of the current licensing guidelines:

• An SFB is mandated to extend 75% of its Adjusted Net Bank Credit (ANBC) to sectors eligible under Priority Sector Lending (PSL).

• Out of this 75%, a minimum of 40% of ANBC must be deployed to specific sub-sectors as prescribed by the RBI’s extant PSL norms—such as agriculture, MSMEs, education, housing, and weaker sections.

• The remaining 35% of ANBC (or Credit Equivalent of Off-Balance Sheet Exposures – CEOBE), could be directed towards any one or more PSL sub-sectors, based on the competitive advantage of the bank.

Revised PSL Provisions from FY 2025-26

Reduction in Overall PSL Obligation

Effective financial year 2025-26, the overall PSL target for Small Finance Banks will be reduced from 75% to 60% of ANBC or CEOBE, whichever is higher. This reflects the RBI’s shift towards a more calibrated and sustainable lending approach for SFBs.

Revised Allocation Framework

Under the revised norms:

• 40% of ANBC or CEOBE, whichever is higher, must still be allocated to the specified PSL sub-sectors, as per the existing RBI PSL prescriptions.

• The remaining 20% can be deployed flexibly across any one or more PSL sub-sectors where the SFB holds competitive advantage.

This change modifies the previous structure where 35% of the ANBC could be flexibly allocated. The reduction from 35% to 20% effectively aligns SFB lending closer to core developmental goals, while also offering some strategic discretion to the banks.

RBI’s Regulatory Authority

These revised instructions have been issued by the Reserve Bank of India under the authority of Section 22(1) of the Banking Regulation Act, 1949, which empowers the RBI to regulate and license banking institutions in India, including prescribing their operational and credit norms.

Implications of the Change

1. Encouraging Focused Lending

By mandating 40% PSL allocation to specific sub-sectors, the RBI ensures that SFBs remain committed to financial inclusion goals, especially targeting segments like rural credit, small and marginal farmers, and underserved MSMEs.

2. Strategic Lending Opportunities

The 20% flexible portion allows SFBs to continue leveraging niche expertise, offering credit to sectors where they demonstrate higher operational efficiency or outreach.

3. Reduced Burden and Risk Diversification

Lowering the PSL obligation from 75% to 60% could provide better balance sheet management opportunities for SFBs and help them diversify credit exposure, without diluting their development-centric objectives.