Closing a Priority Sector Shortfall in an Over-Served District
A mid-sized private bank's lead district office reports a ₹120 crore shortfall against its priority sector target for one district. The district has 2.1 lakh households; 61% have no formal credit account. Four MFIs are active, three charging 24–26%, and a spot survey finds that 74% of existing MFI borrowers already hold three or more loans. The bank is weighing three options: (a) on-lend ₹120 crore to two NBFC-MFIs at 8.2% for three years, which qualifies as priority sector lending; (b) open four rural branches and build a direct joint-liability group book at 16–18%; (c) appoint a for-profit MFI as business correspondent to originate loans in the bank's name. The board wants the shortfall closed 'at minimum cost' before 31 March. The zonal head notes that option (a) can be booked in a week, while option (b) takes about 18 months to break even.
1. Evaluate all three options against the objectives of financial inclusion, not only against priority sector compliance.
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Option (a) - on-lending. Fast, cheap, zero origination cost, and the shortfall disappears in a week. But the bank buys a ledger entry, not a relationship: it cannot control who is finally lent to, at what price (the MFI keeps its 24–26% while funding at 8.2%, a wide intermediation spread), or whether the district's already-strained borrowers take a fourth or fifth loan. In a district where 74% of borrowers already have three or more loans, routing ₹120 crore more through the same channels is likely to deepen over-indebtedness rather than extend inclusion. The bank also gains no deposits, no credit data, and no new-to-credit customer.
Option (b) - direct branches and JLG lending. This is genuine inclusion: new-to-credit borrowers get a credit history, the rate is 16–18% rather than 24–26%, the bank gains CASA and a customer relationship, and it controls conduct. The cost is time and execution risk: 18 months to break-even means the shortfall is not closed this year, and a bank that has never run a JLG book can easily reproduce the MFIs' mistakes - weak income assessment, cash handling risk, and recovery-conduct failures.
Option (c) - business correspondent. The bank owns the credit risk and the conduct risk but not the customer touch. A volume-based BC fee is an incentive to over-lend and mis-sell, and the bank will discover the quality of the book only after the BC has moved on. It is the fastest route to the worst combination: full risk, no control, no relationship.
2. Which option, or combination, would you recommend, and on what conditions?
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A phased blend, with the board told plainly that closing the gap this week and building inclusion over three years are different products.
₹60–70 crore via on-lending, on conditions. Cap the end-borrower all-in effective rate at, say, 22% with a pass-through covenant audited quarterly; require monthly borrower-level reporting of lender count and new-to-credit share; prohibit on-lending to any household already borrowing from three or more lenders; require the MFI's client-protection audit and grievance data; and take a partial guarantee or first-loss cover. Funding is conditional, not a cheque.
₹35–40 crore into two branches (not four), in blocks with no bank branch. Hire locally, cap officer span of control at 400 clients, keep the rate at 16–18%, and set a 24-month target for new-to-credit borrowers rather than for disbursement volume.
One block as a BC pilot, with a fee structure weighted to new-to-credit origination and 30+ repayment quality, not to disbursement; a bank-branded loan card; and the bank's own grievance number on every document.
On the residual shortfall: the board should consider the RIDF route for the balance. A contribution to RIDF is a known cost with no credit or conduct risk; a badly originated ₹120 crore book is an unknown cost with both.
3. What would you track at 12 and 24 months to know whether the choice produced genuine inclusion rather than a compliance artefact?
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Track outcomes, not disbursements.
Access and depth
- Share of borrowers with no prior credit bureau record (new-to-credit) - the single best inclusion indicator.
- Share of borrowers with three or more lenders, from bureau data, by block.
- Share of loans in blocks that had no bank branch at the start.
- Deposits and digital transactions per borrower - evidence of a relationship rather than a single transaction.
Price and conduct
- End-borrower effective rate minus the bank's on-lending rate: the pass-through gap tells you whether cheaper funds reached the client.
- Complaints per 1,000 borrowers, split by category, and resolution time.
- Client-protection audit score for each partner, and recovery-conduct incidents per 10,000 accounts.
Quality and sustainability
- PAR-30 and PAR-60 by block, and the flow rate from the 30 to the 60 bucket - the early signal of appraisal failure.
- Repeat-borrower rate and average ticket growth at 24 months; rapid ticket inflation usually means drift.
- Household enterprise survival or income change at 24 months from a sample survey, which is the only measure that answers whether the credit did anything.
If at 12 months the new-to-credit share is flat, the lender-count share is rising and the pass-through gap is unchanged, the bank has bought a compliance artefact and should say so in the board note.