The Sensex and Nifty were little changed on Wednesday, but state-run lenders such as State Bank of India slipped after the central bank unveiled tough rules for loan restructuring.
Asian markets turned mixed on Wednesday as investor nerves were strained ahead of a U.S. inflation report that could soothe, or inflame, fears of faster rate hikes globally.
While Indian markets were closed on Tuesday for a public holiday, Asian stocks had pulled further away from two-month lows, lifted by Wall Street's extended rebound from last week's steep fall.
Sentiment in India took a hit after the Reserve Bank of India late on Monday tightened its rules around bank loan defaults, seeking to push more large loan defaulters toward bankruptcy courts and abolishing half-a-dozen existing loan-restructuring mechanisms.
While latest consumer inflation data, which showed prices in December had eased from a 17-month high failed to have much impact on banks, it is largely seen as positive for lenders who stand to gain from their government bond holdings. The benchmark 10-year bond yield fell 2 basis points to 7.48 percent.
"We maintain that PSBs (public sector banks) are vulnerable to the NPA- (non-performing asset) related situation," said Deven Choksey, founder, KR Choksey Investment Managers.
The Nifty was up 0.04 percent at 10,543.75, as of 0649 GMT, pulled down by State Bank of India and ICICI Bank.
The Sensex slipped 0.06 percent to 34,282.76.
The Nifty PSU bank index shed as much as 2.8 percent, with SBI leading the decline with a 2 percent fall. Bank of India and Punjab National Bank dropped over 5 percent.
Among gainers, Nifty IT index rose nearly a percent after falling 4.3 percent this month, as of Monday's close.
HCL Technologies and Wipro Ltd gained around 1.5 percent each.