Mandatory Credit Allocation and Government Guarantee

Mandatory credit allocation is a policy intervention to pressure banks to lend to certain sectors otherwise unfettered finance would not give access to. While some would argue that mandatory credit allocation results in sub optimal allocation of resources, it has been shown that such intervention results in socially desirable outcome. However, mandatory credit allocation should not be the responsibility of banks only, it must be supported with government guarantees. There are three sectors in which mandatory credit allocation is given namely the agriculture sector, the micro, small and medium enterprises or MSME sector, and enterprises involved in innovation. In one, the credit allocation is too big, in another too small, and yet in another difficult to identify. In all of these, the banks are left to shoulder the respective mission without government support. Banks either comply or they pay the penalty.