RBI eases PSL norms for SFBs, but limited gains expected

The Reserve Bank of India (RBI) has reduced the priority sector lending target for Small Finance Banks (SFBs) from 75% to 60% starting FY26, easing compliance pressures but offering limited short-term gains. The move frees up around Rs 41,000 crore for SFBs, but the low premium for priority sector lending certificates (PSLCs) may limit their ability to realize short-term gains. CareEdge Ratings says the revised PSL guidelines represent a strategic inflexion point for SFBs, creating a more balanced and practical regulatory framework.

The Reserve Bank of India (RBI) has announced a significant revision to the Priority Sector Lending (PSL) requirements for Small Finance Banks (SFBs), effective from the financial year 2025–26. The new norms reduce the PSL target from 75% to 60% of the Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposures (CEOBE), whichever is higher [1]. This move aims to provide greater operational flexibility and profitability for SFBs while ensuring the continued flow of credit to critical sectors.

Under the revised framework, SFBs will now allocate 40% of their ANBC or CEOBE to specific sub-sectors under the PSL framework, as per existing guidelines. The remaining 20% can be deployed across any PSL sub-sectors where the bank has a competitive edge. This shift is expected to ease compliance pressures and allow SFBs to diversify their portfolios, potentially leading to increased profitability and operational flexibility.

The easing of PSL norms has been widely welcomed by SFBs, with shares of several small finance banks, including ESAF SFB, Ujjivan SFB, and Equitas SFB, rallying by up to 6% on Monday, June 18, 2025 [2]. This positive market reaction reflects investors' optimism about the potential benefits of the new regulations.

However, the low premium for priority sector lending certificates (PSLCs) may limit SFBs' ability to realize short-term gains from the revised PSL guidelines. The CareEdge Ratings has noted that the revised PSL guidelines represent a strategic inflexion point for SFBs, creating a more balanced and practical regulatory framework [1].

The revised PSL norms are expected to come into effect from April 1, 2025, and will provide around Rs 41,000 crore of additional capital for SFBs to deploy in non-PSL lending activities. This capital can be used to expand into new retail or corporate credit products, diversify risk, and better manage asset quality.

In conclusion, the RBI's revision of PSL norms for SFBs is a significant step towards creating a more flexible and balanced regulatory environment. While the immediate impact on SFBs' profitability may be limited by the low premium for PSLCs, the long-term benefits of operational flexibility and risk diversification are expected to be substantial.

References:
[1] https://www.taxscan.in/top-stories/rbi-revises-priority-sector-lending-norms-for-small-finance-banks-psl-target-reduced-to-60-from-fy-2025-26-1425817
[2] https://economictimes.indiatimes.com/markets/stocks/news/ujjivan-esaf-equitas-and-other-small-finance-bank-shares-rally-up-to-6-as-rbi-eases-priority-sector-lending-norms/articleshow/122016396.cms