The Reserve Bank of India has announced a major easing of its priority sector lending (PSL) norms for small finance banks (SFBs), reducing the PSL target from 75% to 60% of adjusted net bank credit (ANBC) or credit equivalent of off-balance sheet exposures, whichever is higher. This change, which will take effect from April 1, 2026, is expected to unlock nearly Rs 41,000 crore, about 15% of SFBs’ total advances as of March 2025, for redeployment into other lending segments.
This regulatory shift comes at a time when SFBs are facing mounting stress in their microfinance portfolios, with gross non-performing assets rising to 4.35% as of March 2025 from 3.5% a year earlier. The relaxation is seen as timely relief, enabling SFBs to rebalance their portfolios, reduce concentration risk, and pursue a more sustainable growth path. It also brings the PSL target for SFBs closer to that of scheduled commercial banks, offering greater operational flexibility and aligning with evolving economic priorities.
With the freed-up capital, SFBs will have the flexibility to expand into lower-risk, secured retail segments such as housing finance, loans against property, personal and vehicle loans, and loans against mutual funds, rather than being heavily concentrated in microfinance and other PSL sectors. This is expected to enhance credit quality and reduce earnings volatility over the medium term.
While the immediate impact on profitability may be limited due to low premiums on Priority Sector Lending Certificates (PSLCs), the move is widely regarded as a structural positive for the sector. It is expected to improve operational efficiency, support balanced growth, and encourage more non-banking financial companies to seek SFB licenses. The announcement was met positively by the market, with shares of leading SFBs such as Equitas and Ujjivan rising following the news.
Industry leaders have welcomed the change, noting that the previous 75% mandate led to challenges such as difficulty in finding quality PSL borrowers, lower margins due to higher risks, and operational constraints. The new norms, they say, shift the focus from volume to value and provide much-needed relief for the sector.
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The PSL compliance requirement for the small and marginal farmers sub-sector, however, remains unchanged at 10% of ANBC, meaning SFBs must still meet this specific target. Overall, the RBI’s revised PSL norms are widely seen as a pivotal development for small finance banks, enabling greater portfolio diversification and providing relief amid rising asset quality stress.
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