Hike in collateral-free agriculture loan limit likely to aid banks in managing stress | Mint

Mumbai: The Reserve Bank of India’s (RBI) recent decision to raise the limit on collateral-free agriculture loans was likely taken to ease the stress being faced by banks in their farm loan portfolios over the past two quarters, and to nudge them to get their books in order.

The RBI on 6 December notified banks to waive collateral security and margin requirements for agriculture loans, including loans for allied activities, up to ₹2 lakh per borrower, from ₹1.6 lakh earlier. The RBI had last hiked the limit from ₹1 lakh to ₹1.6 lakh per borrower in February 2019.

The increase in the limit of collateral-free agriculture will allow farmers and small borrowers to borrow more money, and also free up some of their collateral currently parked with banks, improving their repayment ability at a time when banks’ small-ticket loan books are facing stress, according to experts.

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While the reason cited for the hike in collateral-free agriculture loan limit was high overall inflation and a rise in input costs over the years, industry experts believe the decision was also likely driven by rising asset quality stress in both agriculture and agri-based gold loan (loans taken for agriculture by pawning gold) portfolios of banks. Banks need to implement the new mandate on farm loan limit by 1 January 1, as per the RBI circular.

“It was long due, where collateral-free agri loans were kept at the same threshold of ( ₹1.6 lakh), so it was warranted. But the timing is also possibly due to the build of some stress in banks’ books,” said a senior executive at a private sector bank.

Several banks had reported a rise in their agriculture loan and microfinance non-performing assets (NPAs) in the first quarter of the current financial year, citing disruptions in collections due to the general elections and heatwaves across the country. However, the stress continued in the September quarter as well, forcing lenders such as Axis Bank, IndusInd Bank, Kotak Mahindra Bank, HDFC Bank and AU Small Finance Bank to acknowledge the rise in unsecured delinquencies.

Bank credit to agriculture and allied activities grew 15.5% as of 18 October 2024, compared with 17.4% in the year-ago period, as per the latest RBI data. Agriculture and allied loans, classified as priority sector lending, too slowed down, growing 13.7% as of October, as against 16.8% in the year-ago period. In comparison, bank credit against gold surged 56.2% as against 13.1% in the previous year.

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RBI crackdown

This rise in agri and microfinance institution loans coincided with the RBI crackdown on gold financiers and their lending practices. The measures, which started with temporarily banning IIFL Finance from giving gold loans in March 2024, were later extended to other banks and non-banking financial companies (NBFCs).

While NBFCs such as Muthoot Finance and Shriram Finance were asked to standardize their lending practices including gold storage and auction processes, several public sector banks were pulled up for taking collateral such as gold against collateral-free small-ticket agri loans. It led to a sharp surge in gold loans portfolios of banks, but also caused the stress in the agri book to spillover into the gold loan portfolio, according to experts.

“Total agri gold loan outstanding is estimated at ₹10.0-10.5 trillion, of which ₹6.5 trillion is by PSU banks. These are supposed to be loans for planting crops, but this ₹7 trillion of loans are enough to plant crops on the entire globe, so clearly there is some misuse of the category. This is why RBI is worried about NPAs of gold loans where it is growing in the guise of agri loans,” a senior executive at an NBFC told Mint on the condition of anonymity.

This is also believed to have prompted the RBI to raise concerns about the classification of such loans in its FY24 inspection of PSU banks’ books, given that agriculture loans fall under banks’ priority sector lending (PSL) targets. However, with collateral, these loans are not entirely eligible as PSL. If the RBI officially cracks down on these loans, banks will have to scramble to buy PSL certificates or invest in the National Bank for Agriculture and Rural Development’s (Nabard) Rural Infrastructure Fund to make up for the shortfall on this front.

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While this may be a subtle nudge for banks to get their agri portfolios in order by January, a pickup in agriculture sector growth is also expected to help banks.

As per a report by India Ratings this week, agriculture sector growth in FY25 is expected to accelerate to 3.8% from 1.7% in FY24 and be steady at around 3.4% for FY26. “The better-than-normal 2024 rainfall has lifted the FY25 agriculture growth prospects from 1.7% growth in FY24. Since a portion of rabi production is harvested in the first quarter of next financial year, the impact of better-than-normal rainfall in 2024 is improving the growth prospects of the agricultural sector for FY25-FY26,” the report said.