MUMBAI: Indian lenders will appeal against a central bank proposal to tighten rules for infrastructure project loans, according to a banker and a source familiar with the matter.

The Indian Banks Association (IBA) is gathering inputs and will write to the central bank, opposing the imposition of higher provisions for under-construction projects, they said.

The provisioning requirement looks a little high, said S.L. Jain, chief executive officer of government-owned Indian Bank. The issue will be discussed with the IBA and a request will be sent to the RBI, Jain said.

The central bank proposed on Friday that banks set aside a provision of 5% of the loan amount for projects at the construction phase. This can be reduced to 2.5% when the project becomes operational, and 1% when a certain level of cash flow is achieved.

This could lead to a 1-1.5 percentage point increase in interest rate for project finance loans, said the source, a senior banker at an infrastructure finance institution.

Sectors such as renewable energy that operate at slim margins will be hit the hardest if interest rates rise, the source said, confirming that lenders will seek a reduction in the levy.

The government is still to firm up its view on the rules, but unintended consequences such as reluctance to lend for under-construction projects would need to be considered, said a third person familiar with the government's thinking.

The proposed rules can be altered based on feedback received till June 15.

The IBA did not immediately respond to a request for comment.

Indian lenders saw a surge in bad loans starting 2012-13 as several infrastructure-related borrowings turned sour after the global financial crisis in 2008.

Long delays in implementing projects and exuberant revenue projections led to large defaults and made lenders averse to the infrastructure sector.

A majority of infrastructure projects are now driven by the government or government-owned entities, which means the default risk is low, a source said.

The central bank's proposal led to a sell-off in share prices of government owned banks and non-bank lenders that lend for infrastructure and project finance, with analysts saying that the higher provisions will dent profitability on project loans and deter such lending.

These rules, if implemented in the current form, can significantly dampen recovery in project finance and capital expenditure in the economy, said Macquarie in a research note on Tuesday.

(Reporting by Ira Dugal and Siddhi Nayak; Editing by Shinjini Ganguli)