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In a significant move to recalibrate the regulatory framework for small finance banks (SFBs), the Reserve Bank of India (RBI) has revised the priority sector lending (PSL) requirements, reducing the overall PSL target from 75% to 60% of Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposures (CEOBE), whichever is higher. The revised norms will be applicable from the financial year 2025-26 onwards.
The decision marks a shift from the earlier mandate, which required SFBs to dedicate 75% of their lending towards sectors classified under PSL. Of this, 40% had to be mandatorily allocated to specific sub-sectors like agriculture, micro-enterprises, education, housing, and others, while the remaining 35% could be channelled flexibly into any PSL sub-sectors where the bank had a competitive advantage.
July 2025
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"The RBI’s decision seems like a move to gradually align them (SFBs) with the operating framework of universal banks. From a regulatory standpoint, this eases some pressure, especially as many SFBs expand into more competitive markets,” said Kunal Varma, founder and CEO, Freo.
"However, the concern lies in how this may impact credit access for the underserved. SFBs were envisioned to fill a gap, especially for small borrowers, informal-sector enterprises, and rural credit needs. The reduced mandatory target, along with lower sub-target flexibility, could affect the quantum and quality of credit available to these segments unless SFBs consciously retain their developmental intent," he added.
Despite the relaxation, the RBI has retained a significant 40% sub-sectoral mandate, ensuring that the core mission of SFBs—providing banking services to underserved segments—remains intact.
"It’s a fine balance between granting operational freedom to SFBs and ensuring they don’t lose their original purpose. The challenge now is for these banks to maintain that mission-driven edge while growing sustainably," said Varma.
Moreover, the RBI continues to exercise its regulatory authority under Section 22(1) of the Banking Regulation Act, 1949, to issue such directions and ensure prudential norms are adhered to.
What lies ahead
Going forward, SFBs may use the additional leeway to strengthen their retail secured portfolios, enter new segments such as gold loans or vehicle finance, or deepen relationships in geographies where they enjoy strong operational linkages.
For borrowers in the priority sector, particularly micro-entrepreneurs and small farmers, this could mean a marginally more competitive environment, as banks become selective in PSL deployment. However, the overall 40% mandate ensures they remain a central part of SFBs’ lending universe.
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