The Reserve Bank of India (RBI), in a recent Notification No. RBI/2025-26/61 dated 20.06.2025, has reduced the Priority Sector Lending (PSL) target for Small Finance Banks (SFBs), effective from the financial year 2025-26.
Key Highlights:
- The RBI has reduced the PSL target for SFBs from 75% to 60% of their Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposures (CEOBE), whichever is higher.
- The SFBs shall continue to allocate 40% of its ANBC or CEOBE, whichever is higher, to different sub-sectors under PSL as per the existing guidelines.
- The remaining flexible component has been reduced from 35% to 20%, allowing SFBs to allocate to any one or more sub-sectors under the PSL.
Legal Analysis
The revised PSL norms for SFBs have been issued under the powers conferred on the RBI under Section 22(1) of the Banking Regulation Act, 1949. The Priority Sector Lending (PSL) requirement was introduced through the 'Guidelines for Licensing of Small Finance Banks in Private Sector' dated November 27, 2014, and the 'Guidelines for 'on-tap' Licensing of Small Finance Banks in Private Sector' dated December 05, 2019.
Legal Framework: The 2014 Guidelines prescribed that SFBs will be required to extend 75% of its ANBC to the sectors eligible for classification as PSL by the RBI. The promoter's minimum initial contribution to the paid-up equity capital of such SFB shall be at least 40% and to be gradually reduced to 26% within 12 years from the date of commencement of business of the bank.
The 2019 Guidelines updated capital requirements and introduced 'on tap' licensing, i.e., a window for getting a bank license from the RBI, which is open throughout the year. The revised guideline of reduction to 60% PSL effectively modifies the compliance requirement without altering the core legal obligation of SFBs to serve underbanked segments. The reduction in discretionary allocation from 35% to 20% narrows the leeway SFBs have in concentrating their PSL exposure based on internal strategy.
Significance:
The relief comes at a well-timed pace, as SFBs have been witnessing an increase in gross Non-Performing Assets (NPAs) due to a high concentration in microfinance lending. Implicitly, SFBs can now reduce concentration risk, rebalance their allocations, and strive for more inclusive growth. By lowering the PSL level, SFBs would have more freed-up capital to invest in low-risk or high-yielding sectors which would improve asset quality and profitability.
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