FY2025-26 Priority Sector Lending (PSL) Regulatory Overhaul: UPSC Current Affairs Story Arc

Overview

The FY2025-26 Priority Sector Lending (PSL) Regulatory Overhaul represents a strategic recalibration of how credit flows to India's underserved sectors. Initiated by the RBI in March 2025, the overhaul introduced flexible 'multi-target' counting for Priority Sector Lending Certificates (PSLCs) and updated the overall guidelines to include broader limits for housing and renewable energy. A pivotal moment occurred on June 26, 2025, when the RBI reduced the mandatory PSL target for Small Finance Banks from 75% to 60% of their net credit. This shift aims to improve bank profitability and liquidity (buttressed by a 6% boost in Liquidity Coverage Ratios) while ensuring that at least 40% of lending remains strictly dedicated to core priority sectors like agriculture and MSMEs.

How This Story Evolved

RBI introduces new PSL guidelines (Item 7) and PSLC rules (Item 4) → Guidelines become effective with LCR amendments (Item 15) → RBI subsequently eases PSL targets specifically for Small Finance Banks (Item 5)

1. 2025-03-10: RBI Introduces New PSL Guidelines Effective April 1, 2025
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   UPSC Angle: RBI introduces new PSL guidelines effective April 1, 2025.

   Key Facts:

   • RBI: Reserve Bank of India
   • PSL: Priority Sector Lending
   • Effective Date: April 1, 2025
   • Rural Infrastructure Development Fund (RIDF)
2. 2025-03-10: RBI Allows PSLC for Small and Marginal Farmers to Count Towards Multiple Targets
   More details

   UPSC Angle: PSLC for Small and Marginal Farmers counts towards multiple targets.

   Key Facts:

   • RBI: Reserve Bank of India
   • PSLC: Priority Sector Lending Certificates
   • PSLC-SF/MF: PSLC for Small and Marginal Farmers
   • SF/MF: Small/Marginal Farmers sub-target
   • NCF: Non-Corporate Farmers sub-target
   • PSL: Overall Priority Sector Lending
3. 2025-04-01: RBI Enhances Liquidity and Widens Priority Sector Lending
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   UPSC Angle: RBI amended LCR framework to enhance banks' liquidity resilience.

   Key Facts:

   • RBI amended the Liquidity Coverage Ratio (LCR) framework in April 2025
   • LCR of banks is estimated to improve by around 6 percentage points
   • Effective April 1, 2025, RBI revised Priority Sector Lending (PSL) guidelines
   • PSL guidelines widened coverage and raised loan limits across various sectors
   • PSL target for urban cooperative banks increased to 60% of adjusted net bank credit
4. 2025-06-26: RBI Eases Priority Sector Lending Norms for Small Finance Banks
   More details

   UPSC Angle: RBI eases priority sector lending norms for Small Finance Banks.

   Key Facts:

   • RBI has reduced the Priority Sector Lending target for Small Finance Banks
   • PSL target reduced from 75% to 60%.
   • 40% mandatory for core PSL sectors.
   • 20% flexible for non-PSL secured loans.
   • Effective from FY 2025-26.
   • RBI reduced PSL target for SFBs from 75% to 60%.
   • Aims to enhance lending flexibility and profitability.

Genesis

Trigger

On March 10, 2025, the RBI announced a comprehensive set of new PSL guidelines and PSLC rules effective from the start of the next financial year (April 1, 2025).

Why Now

The guidelines were timed to coincide with the new fiscal year (FY2025-26) to synchronize banking compliance with fresh Liquidity Coverage Ratio (LCR) amendments, ensuring banks had the liquidity cushion to expand credit coverage.

Historical Context

Priority Sector Lending targets (historically 40% for SCBs and 75% for RRBs/SFBs) have long been a tool for social banking in India, originally codified to ensure credit availability for sectors like agriculture that might otherwise be ignored by commercial logic.

Key Turning Points

1. [2025-03-10] RBI introduces multi-target counting for PSLC-SF/MF

   It simplified compliance for banks by allowing a single loan to satisfy multiple regulatory sub-targets (e.g., Agriculture and Weaker Sections).

   Before: Banks struggled to fulfill specific sub-targets individually. After: Lending to a small farmer provides credits across 5 distinct regulatory categories.

2. [2025-06-26] Relaxation of SFB targets from 75% to 60%

   This acknowledged that the 75% target was a burden on SFB profitability and aligned them closer to the revised targets of Urban Cooperative Banks.

   Before: SFBs were locked into a 75% rigid target. After: 40% is core mandatory, while 20% can be used for non-PSL secured loans to boost profit.

Key Actors and Institutions

Key Institutions

• Reserve Bank of India (RBI)
• Small Finance Banks (SFBs)
• Urban Cooperative Banks (UCBs)
• Rural Infrastructure Development Fund (RIDF)
• NABARD

Key Concepts

Priority Sector Lending (PSL)

A regulatory requirement where banks are mandated to dedicate a portion of their lending to specific sectors like agriculture and MSMEs to ensure financial inclusion.

Current Fact: Effective April 1, 2025, the PSL target for Urban Cooperative Banks was raised to 60% of adjusted net bank credit.

Priority Sector Lending Certificates (PSLC)

Tradable certificates that allow banks to meet their PSL targets by buying 'credits' from other banks that have exceeded their lending requirements.

Current Fact: As of March 10, 2025, PSLC-SF/MF (Small/Marginal Farmers) now count toward five different sub-targets simultaneously.

Liquidity Coverage Ratio (LCR)

A Basel III requirement where banks must hold enough high-quality liquid assets (HQLA) to survive a 30-day stress scenario.

Current Fact: Amendments in April 2025 are estimated to improve banks' LCR by approximately 6 percentage points.

What Happens Next

Current Status

As of June 26, 2025, the regulatory environment has stabilized with a relaxed 60% PSL target for Small Finance Banks, comprising 40% mandatory core PSL and 20% flexible non-PSL secured loans.

Likely Next

Expected monitoring of credit flow to Small and Marginal Farmers (SF/MF) to see if the 'multi-target' PSLC rules lead to over-concentration or genuine credit expansion.

Wildcards

Potential inflationary pressure could lead to a tightening of liquidity, negating the 6 percentage point LCR gain and forcing a revisit of the flexible 20% non-PSL quota.

Why UPSC Cares

Syllabus Topics

• Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment
• Inclusive growth and issues arising from it

Essay Angles

• Balancing Social Responsibility with Economic Profitability in Banking
• The Evolution of Financial Inclusion: From Mandatory Targets to Market Mechanisms

Prelims Likely: Yes

Mains Likely: Yes

Trend Signal: rising

Exam Intelligence

Previous Year Question Connections

• What constitutes PSL lending (Agriculture, MSME, etc.)? — The 2025 overhaul expands these categories specifically in housing and renewable energy (Item 3).
• Purpose of setting up Small Finance Banks (SFBs). — The June 2025 relaxation directly impacts the operational viability of SFBs mentioned in this PYQ.
• Fact: RIDF was instituted in NABARD during 1995-96. — The new guidelines reiterate that banks failing PSL targets must contribute to the RIDF (Item 1).

Prelims Angles

• The new PSL target for Urban Cooperative Banks is 60% of Adjusted Net Bank Credit (ANBC).
• The reduced PSL target for Small Finance Banks is 60%, with a 40% core mandatory component.
• PSLCs for Small and Marginal Farmers now count towards exactly five targets: SF/MF, Weaker Sections, NCF, Overall Agriculture, and Overall PSL.
• Non-compliance with PSL targets leads to mandatory contributions to the Rural Infrastructure Development Fund (RIDF).

Mains Preparation

Sample Question: Critically analyze the Reserve Bank of India's decision to relax the Priority Sector Lending (PSL) targets for Small Finance Banks in 2025. How does this move reconcile the dual objectives of financial inclusion and institutional profitability?

Answer Structure: Intro: Define PSL and the June 2025 shift for SFBs (75% to 60%) → Body 1: Benefits for SFBs (profitability, flexibility in the 20% non-PSL quota, LCR improvement) → Body 2: Impact on Financial Inclusion (maintenance of 40% core target, efficiency of multi-target PSLCs) → Critical Analysis: Potential risk of credit diversion vs. the necessity of viable niche banks → Conclusion: The 2025 overhaul as a move toward 'smart' regulation over 'rigid' mandates.

Essay Topic: Financial Inclusion: Not Just a Target, But a Sustainable Ecosystem.

Textbook Connections

Key Takeaway

The 2025 PSL overhaul shifts the regulatory focus from high-volume mandates to high-efficiency compliance through certificate flexibility and target convergence (60%) for specialized banks.

All Events in This Story (4 items)

1. 2025-03-10 [Economy] — RBI Introduces New PSL Guidelines Effective April 1, 2025
   The Reserve Bank of India (RBI) has introduced new guidelines for Priority Sector Lending (PSL), effective from April 1, 2025, designed to channel more credit into critical areas such as agriculture, MSMEs, education, housing, and renewable energy, supporting sustainable economic development. Banks failing to meet their PSL targets must contribute to the Rural Infrastructure Development Fund (RIDF) and other designated funds at predetermined interest rates.
   More details

   UPSC Angle: RBI introduces new PSL guidelines effective April 1, 2025.

   Key Facts:

   • RBI: Reserve Bank of India
   • PSL: Priority Sector Lending
   • Effective Date: April 1, 2025
   • Rural Infrastructure Development Fund (RIDF)
2. 2025-03-10 [Economy] — RBI Allows PSLC for Small and Marginal Farmers to Count Towards Multiple Targets
   RBI recently made changes to the rules for Priority Sector Lending Certificates (PSLCs), where the PSLC for Small and Marginal Farmers (PSLC-SF/MF) will now count towards multiple targets, including Small/Marginal Farmers (SF/MF) sub-target, Weaker Sections sub-target, Non-Corporate Farmers (NCF) sub-target, Overall Agriculture target, and Overall Priority Sector Lending (PSL) target. This change aims to help banks meet their Priority Sector Lending (PSL) obligations more easily.
   More details

   UPSC Angle: PSLC for Small and Marginal Farmers counts towards multiple targets.

   Key Facts:

   • RBI: Reserve Bank of India
   • PSLC: Priority Sector Lending Certificates
   • PSLC-SF/MF: PSLC for Small and Marginal Farmers
   • SF/MF: Small/Marginal Farmers sub-target
   • NCF: Non-Corporate Farmers sub-target
   • PSL: Overall Priority Sector Lending
3. 2025-04-01 [Economy] — RBI Enhances Liquidity and Widens Priority Sector Lending
   In April 2025, the Reserve Bank of India (RBI) amended the Liquidity Coverage Ratio (LCR) framework to enhance banks' liquidity resilience, which is estimated to improve banks' LCR by approximately 6 percentage points. Effective April 1, 2025, the RBI also revised Priority Sector Lending (PSL) guidelines to broaden coverage and increase loan limits across sectors like housing and renewable energy, raising the overall PSL target for urban cooperative banks to 60% of adjusted net bank credit.
   More details

   UPSC Angle: RBI amended LCR framework to enhance banks' liquidity resilience.

   Key Facts:

   • RBI amended the Liquidity Coverage Ratio (LCR) framework in April 2025
   • LCR of banks is estimated to improve by around 6 percentage points
   • Effective April 1, 2025, RBI revised Priority Sector Lending (PSL) guidelines
   • PSL guidelines widened coverage and raised loan limits across various sectors
   • PSL target for urban cooperative banks increased to 60% of adjusted net bank credit
4. 2025-06-26 [Economy] — RBI Eases Priority Sector Lending Norms for Small Finance Banks
   The Reserve Bank of India (RBI) has relaxed priority sector lending (PSL) norms for Small Finance Banks (SFBs). The PSL target has been reduced from 75% to 60% to enhance lending flexibility and profitability. The new rule, effective from FY 2025-26, mandates 40% for core PSL sectors, with the remaining 20% allowed for non-PSL secured loans.
   More details

   UPSC Angle: RBI eases priority sector lending norms for Small Finance Banks.

   Key Facts:

   • RBI has reduced the Priority Sector Lending target for Small Finance Banks
   • PSL target reduced from 75% to 60%.
   • 40% mandatory for core PSL sectors.
   • 20% flexible for non-PSL secured loans.
   • Effective from FY 2025-26.
   • RBI reduced PSL target for SFBs from 75% to 60%.
   • Aims to enhance lending flexibility and profitability.