Relief washes over the banking sector today. The Reserve Bank of India (RBI) has delivered its final guidelines on provisioning for project finance loans, effective October 1, 2025, stepping back significantly from the stringent draft norms proposed last year. This calibration is set to ease some pressure on banks and potentially cheer the markets.

The earlier draft guidelines had sent shivers down the spines of lenders, proposing a steep 5 percent provision requirement for loans on projects still under construction. Compare that to the existing 0.4 percent standard, and you see why banks were concerned about billions being locked away, potentially hindering future lending.

New Provisioning Standards

The final rules offer a much more manageable figure: 1 percent provisioning for most under-construction projects. Commercial real estate projects, often considered riskier, face a slightly higher 1.25 percent provision during construction. This tiered approach appears sensible, acknowledging the higher risk during the building phase while not imposing an excessive burden.

Crucially, once a project becomes operational and starts generating revenue, the provision drops to 0.4 percent or 0.75 percent, depending on the asset type. This reflects a recognition that income-generating projects pose lower credit risks.

What This Means for Banks

The primary benefit for banks is simple math. A 1 percent provision requires far less capital set-aside than a 5 percent mandate. This frees up capital that banks can then deploy for other lending activities, supporting broader economic activity. A M Karthik, a senior analyst at ICRA, rightly notes that the 1 percent provision is considerably less crippling than the initially proposed 5 percent. Existing loans, those already on the books before October 2025, get a pass unless restructured, avoiding disruptive changes.

Flexibility Meets Oversight

The RBI hasn’t just softened the numbers; they’ve also introduced flexibility for project delays, a common hurdle in large infrastructure projects. If a project’s commercial operations date is pushed back, provisioning increases incrementally (by 0.375 percent or 0.5625 percent quarterly, depending on the sector). This penalises delays without immediately pushing loans into stressed categories.

However, the RBI is also tightening oversight. The guidelines call for enhanced monitoring of project progress and timely reporting of issues. While the 1 percent provision is lower than the draft, it is still more than double the previous standard, requiring greater discipline from lenders. This focus on better monitoring is likely a lesson learned from past episodes of mounting bad loans.

Other Regulatory Adjustments

In a separate move indicating the RBI’s ongoing regulatory calibration, the central bank also revised the priority sector lending (PSL) norms for small finance banks (SFBs). Effective FY26, SFBs will see their overall mandatory PSL target reduced from 75 percent to 60 percent of adjusted net bank credit. This includes a 40 percent allocation to core PSL sub-sectors and 20 percent flexibility. This change aims to give SFBs more operational flexibility and potentially cater to a wider range of market opportunities.

What does this all mean? The RBI appears to be seeking a balance: pushing banks towards greater risk awareness and discipline without stifling their ability to lend, especially for critical infrastructure and development projects. Expect banks to cautiously reassess their project finance pipelines now that the regulatory uncertainty has lessened.

Image courtesy: X (Ministry of finance)