Explained: How Banks Earned or Engineered PSL Compliance

In Investigation
January 23, 2026
Sandeep Deshpande
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Priority Sector Lending targets may be met on paper, but compliance looks very different across banks. While public sector and small finance banks earn PSL through direct lending, many private and foreign banks engineer compliance using intermediaries and PSL certificates. RBI’s 2026 reforms now aim to separate genuine credit delivery from regulatory optimisation.

Mumbai (ABC Live): Priority Sector Lending (PSL) is often described as a tool of financial inclusion. In practice, however, it works more like a regulatory allocation tool. It requires banks to send a fixed share of credit to sectors that matter for the economy—such as agriculture, MSMEs, affordable housing, and microcredit—but which are usually ignored by pure risk-return logic.

As a result, PSL does not merely increase lending to priority areas. Instead, it reshapes how bank balance sheets are used across the system.

This is precisely where the compliance debate begins.

Because bank models differ sharply—public sector banks (PSBs) with rural reach, private banks focused on urban retail and corporates, and small finance banks (SFBs) built for small borrowers—PSL compliance is not uniform. Rather, it falls on a spectrum. At one end is direct origination. At the other is regulatory optimisation, mainly through on-lending and Priority Sector Lending Certificates (PSLCs).

Against this backdrop, the January 19, 2026 amendments issued by the Reserve Bank of India must be read carefully. On the one hand, the RBI has widened channels by allowing new institutions such as the National Cooperative Development Corporation (NCDC). On the other hand, it has tightened audits, caps, and reporting rules.

What RBI changed — and what it signals

The Priority Sector Lending (Amendment) Directions, 2026 revise the 2025 Master Directions. Importantly, the changes focus less on targets and more on how compliance is achieved.

1. NCDC added as an on-lending channel, but with strict checks

Bank loans to NCDC for on-lending to cooperative societies now qualify as PSL. However, this is allowed only if banks submit quarterly certificates from CAG-empanelled auditors. These certificates must confirm two things:

the money went to PSL-eligible uses, and
no other bank has claimed the same exposure.

Therefore, while RBI is widening the pipeline, it is also insisting on clear tracking and no double counting.

2. Clear cap on on-lending exposure (including NCDC)

At the same time, RBI has reinforced an overall cap. Bank credit to NBFCs, HFCs, and NCDC for on-lending can count as PSL only up to 5% of the bank’s previous year PSL, averaged over four quarters.

In other words, on-lending is meant to support PSL, not replace direct lending.

3. Small Finance Banks’ PSL target fixed at 60%

The amendment confirms that Small Finance Banks must meet a 60% PSL target, not 75%.

Notably, ABC Live has already explained why this shift matters—balancing inclusion with the survival of specialised lenders:
👉 https://abclive.in/2025/10/28/indias-small-finance-banks/

4. Export credit rules clarified

In addition, RBI has clarified that export credit to agriculture and MSMEs qualifies as PSL under defined limits. As a result, confusion in classification and reporting is reduced.

How banks comply in reality: three engines

In practice, banks use a mix of three methods:

Direct lending
This is the cleanest route and best matches the policy goal.
On-lending or co-lending
This improves reach and speed. However, it also raises audit and tracking risks.
PSL Certificates (PSLCs)
These allow banks to buy or sell PSL compliance in the market. While efficient, they can weaken the link between compliance and real lending.

RBI’s PSL FAQs underline two key facts.
First, banks may buy PSLCs to meet targets.
Second, banks may issue PSLCs up to 50% of their previous year PSL achievement even without holding the loans, with only the net position reported.

Consequently, PSLCs help smooth compliance. Yet, weak oversight can lead to compliance without real lending capacity.

Bank-wise compliance: who lends and who optimises

Table 1: Bank-group compliance patterns

Bank group	Typical behaviour	Main route	Strength	Weakness
Large PSBs	PSL as default lending	Direct	Rural reach; legacy pipelines	Credit risk cycles
Large private banks	PSL as constraint	Mixed routes	Data-driven scale	Audit and PSLC reliance
Small Finance Banks	PSL as core business	Direct	Deep last-mile reach	Concentration risk
Foreign banks	PSL as mismatch	PSLC-heavy	Balance-sheet efficiency	Thin origination

Table 2: What auditors usually flag

Bank type	Positive signs	Common red flags
PSBs	Stable agri/MSME books	End-use gaps; waiver exposure
Private banks	Strong systems	March-end PSL patching
SFBs	Very high PSL share	Funding cost stress
Foreign banks	Clean reporting	Compliance mainly purchased

The core critique: numbers look fine, substance does not

First, compliance is concentrated

System-wide PSL ratios appear healthy. However, most real lending still comes from PSBs and SFBs. Meanwhile, many private and foreign banks rely more on instruments and intermediaries.

Second, auditability is now the key issue

The 2026 changes make this clear. While RBI has added new channels, it has also demanded proof through audits and caps. As a result, the key question has shifted from “Did you meet the target?” to “Can you prove every rupee?”