Does Priority Sector Lending Affect Banks’ Financial Performance?

Abstract The study investigates the impact of Priority Sector Lending (PSL) on the financial performance of 31 banks operating in Bangladesh from 2012 to 2021. Out of 31 banks, the study includes 27 Private Commercial Banks (PCBs) and 4 State Owned Commercial Banks (SOCBs). Banks’ lending for agricultural sectors and Cottage, Micro, Small and Medium Enterprises (CMSME) are considered as lending for priority sectors. The study employs the Random Effect estimator to measure banks’ profitability due to PSL. Also, it uses panel-corrected standard errors to verify the robustness of the estimation obtained from the Random Effect estimator with VCE robust standard error. The study shows no significant relationship between the banks’ lending for priority sectors and the profitability of banks (ROA). Based on the primary survey, the study finds that bank lending in the priorities sector faces problems of a poor selection of PSL borrowers, a shortage of personnel at the bank level to supervise PSL loans, a lack of financial awareness among PSL borrowers, and an increase in NPL. The study also reveals that the size of the banks' assets (TA), NPL and ADR show a negative relationship with ROA. CAR, GDP, and INF show a significant and positive relationship with ROA. No significant relationship is found between CIR and ROA. The study suggests regulators should address weaknesses in regulatory oversights and implement stringent monitoring mechanisms so that banks increase significant involvement in PSL with adequate personnel and capacity development and borrowers' lack of financial literacy. JEL Classification: H81 Keywords: Priority Sector Lending , Profitability , Random Effect Model , Panel Corrected Standard Errors