India’s Evolving Banking Landscape: A Deep Dive into RBI’s Revised Liquidity Coverage Ratio and Project Financing Norms

[Shubham Sharma and Shivanshu Shivam are students at Chanakya National Law University]

Introduction

In the decades following the global financial crisis of 2007–2009, financial regulators worldwide have been recalibrating their frameworks to protect the banking system's stability. In this regard, the Reserve Bank of India (“RBI”) has pioneered the efforts in India, evolving its regulatory policies fitting to global standards as much as they cater to domestic economic imperatives. Rapid technological advancements have recently led the RBI to propose some highly significant revisions to two key regulatory pillars namely, the Liquidity Coverage Ratio (“LCR”) framework and project financing norms vide draft guidelines on Liquidity Risk Management Framework for Non-Banking Financial companies and Core Investment Companies (the “proposed measures on LCR”) and draft Prudential Framework for Income Recognition, Asset Classification and Provisioning pertaining to Advances - Projects Under Implementation, Directions, 2024 (the “proposed project financing norms”) respectively (collectively, the “proposed measures”).

The proposed measures set out to force banks to have high-quality liquid assets (“HQLA”) sufficient to meet net cash outflows during a 30-day stress period and to follow a more risk-sensitive credit provisioning approach, especially to the loan books of under-construction projects which were originally aimed to be introduced in April 2025. However, after a series of consultations with the industry stakeholders and keeping in view the operational concerns of the banks, RBI Governor Sanjay Malhotra said that these proposed measures will be enforced till March 31, 2026, at least.

In this piece, the authors have examined the proposed measures by the RBI within the relevant global and domestic context and evaluate the implications of these measures on the banking industry.

Global Regulatory Context and Domestic Imperatives

The Basel III is the adopted framework that came to be in response to the 2007–2009 financial crisis due to which globally there was a global overhaul of banking regulations. A key Basel III obligation is for banks to hold HQLA covering 30-day cash outflows, called the LCR. Through this measure, banks would not collapse, forced to sell off assets to the markets to get to the markets for emergency funding.

Regulators have also globally reformed the standards of credit risk provisioning to make sure banks have enough capital to compensate for potential losses, mainly on higher risk segments like infrastructure financing.

India’s banking sector faces unique challenges. Rapid digitization has changed how customers conduct business as well as process their finances, which has increased digital banking channels such as mobile and internet banking at unprecedented levels. Also, the government’s high and ambitious project financing in the highway, airport, and urban development programmes has tremendously increased demand for the service.

However, these developments have shown gaps in the existing framework and highlight the need to revise it so that the RBI proposals not only reconcile with the global benchmarks but address the characteristics of the domestic economy.

It is on account of such global regulatory trends as well as domestic imperatives that the proposed measures of the RBI are located where they are. To make the RBI’s banking system more resilient to liquidity shocks, credit losses, and economic growth in a fast pace of digital and infrastructure development, the RBI has enhanced the LCR framework and revised the project financing norms.

Conceptual Underpinnings of the Revised Liquidity Coverage Ratio

In recent years, global regulators have been increasingly recognizing that digital banking brings volatility that is not as severe as in traditional banking channels. The LCR is a key tool in preventing banks from not meeting short-term obligations in the event they need to do so. In the current framework, banks in India have to maintain an LCR of 100 percent or more. Hence, HQLA, being cash plus liquidity reserves held with the central bank and government paper, should be no less than projected net cash outflows over a 30-day time horizon.

While this framework retains an older form, the RBI’s proposed measures on LCR introduce an innovative modification to it, namely by confining the focus to digitally enabled retail deposits. Customer behaviour significantly has changed in the wake of the surge in digital banking. Recent years have seen digital transactions in India grow by more than 50 percent, which is both a blessing and a curse for new risks that these transactions have also ushered in. Instantaneous withdrawals provide in a crisis a large number of deposits that can be withdrawn very quickly.

In order to overcome this risk, the RBI’s proposed measures on LCR proposes a 5 percent more run-off factor for digitally accessible deposits. This conceptually arises when banks calculate the net cash outflows under a stress scenario and have to believe that 5 percent more of these digitally enabled deposits will be withdrawn than could occur in the classic deposit case.

Revisiting Project Financing Norms: Aligning Provisions with Risk

It is well known that infrastructure projects help breathe in the lifeblood of economic development, growth, and improving quality of life and infrastructure. However, project risk is particularly high when an under-construction project is concerned because it involves uncertainties such as project delay, cost overrun, regulatory bottlenecks, etc. These projects have traditionally been provided credit by banks using lenient provisioning norms of 0.4 percent or less based on optimistic assumptions about the project completion and stabilization of cash flows.

However, the RBI’s proposed project financing norms are a huge departure from traditional practices requiring lenders to maintain a general provision of 5 per cent on existing as well as fresh exposures on a portfolio basis to under-construction projects.  However, the draft proposals propose a staged rise in the above provisioning requirement increasing from 2 percent in FY 2025, up to 3.5 percent in FY 2026 and hitting 5 percent in FY 2027. By not establishing overdrafts at the outset, it allows banks to incrementally increase their risk management practices over time, such that capital buffers established against these loans may more closely reflect that actual exposure.

A beneficiary of this conceptual higher provisioning is an attempt to act as a buffer against the higher default risks related to infrastructure projects. And, through such a gradual ramp-up of provisions, RBI intends that there is no quick loss setting in so that the probability of a systemic crisis is reduced.

Implications of the proposed measures on the Banking Sector

The proposed measures have a wide impact on the banking sector. Firstly, banks must reallocate a significant portion of their assets. The increase of the run-off factor for digitally enabled deposits by 5 percent in the context of the enhanced LCR framework will result in the increased volume of HQLA being held by the banks. That reallocation means that money that could have been used for lending or some higher-yielding asset, will instead be trapped in government securities and central bank reserves. Such reallocation of funds is such a large number that it would restrict the amount of credit available and also possibly, would hinder economic activity in such a short time when liquidity is already under strain.

Secondly, since the new norms are aimed at strengthening the balance sheet of many public sector banks which tend to have better liquidity profiles, public sector banks can find it easier to comply with the new norms. On the other hand, many private sector banks, which are often in a stricter liquidity margin, may experience greater operational difficulty and enhanced pressure on the balance sheet.

Thirdly, the new project financing norms add to the complexity of the landscape by demanding provision for an additional amount for under-construction projects. The requirement is expected to prevent infrastructure projects from securing bank credit in such a manner that the cost of financing is likely to rise, and will impact sectors based heavily on bank credit like transportation, energy, and urban development. The new regulatory requirements will require banks to recalibrate the internal risk models, make the credit appraisals, and invest in IT infrastructure—all expensive exercises and resource-intensive.

Way Forward

The delayed implementation of RBI’s revised Liquidity Coverage Ratio and project financing norms till March 31, 2026, is a good one because of the upheavals before India’s banking sector. Allowing banks to have measured delay, ensures the critical time banks need to upgrade technological infrastructure, recalibrate risk management systems, and rebalance capital allocations to protect both liquidity and the flow of credit. Built on international best practices and based on a large amount of stakeholder feedback, new regulations require banks to hold more high-quality liquid assets and to prudently provision for under-construction projects.

This is a strategic, phased approach towards preventing an abrupt disruption but to be an environment way that can support sustained economic growth. The RBI is achieving this by balancing the two imperatives of prudence and the envelope of credit availability and creating a more resilient, flexible, and resilient banking system. These regulatory reforms will ensure the banking system remains resilient to future challenges.