Since 2012, tens of millions of dollars from the scheme have been used to fund projects that critics say should be funded by government departments. These include upgrades to Muswellbrook Hospital's emergency department, and restoration of the sea wall and footpaths in Newcastle City.

The Association of Mining Related Councils - which represents local councils on mining issues, and which first called for a local royalties scheme 10 years ago - says government departments should not abuse the process.

Its deputy chair, Wollongong Councillor Chris Connor, said the purpose of the scheme was to return a proportion of royalties to local communities.

"We think that's a disturbing trend that government departments are bidding for money that was going through mining royalties — particularly in the Illawarra and Wollongong where our infrastructure is very much affected by mining and the transportation of raw materials to the port." he said.

"It's a shame that the government is seeing this as a way they can get around funding directly from Treasury to government departments ... taking it out of the bucket of money that should be going to regional infrastructure."

A spokesman for Deputy Premier Andrew Stoner denied it was inappropriate for government departments to use Resources for Regions for extra funding.

"The objective of Resources for Regions is to fund projects that will improve local infrastructure in mining affected communities, and this includes health infrastructure projects and services, which are crucial for local communities," he said.

"The assessment process allows the NSW Government to take a regional view when prioritising projects for funding, ensuring funds are directed to where they are needed most. Having a range of agencies review and consider applications means the public can be confident that a comprehensive assessment of a project's merit has been undertaken."

Wollongong Lord Mayor Gordon Bradbery said the program must be reformed for greater transparency.

"It seems to me that there are too many people who are playing around in the assessment of this. I think Infrastructure NSW might be a suitable place to assess some of these things, and might have an opinion, but ultimately the allocation should be on the basis of the impact of mining on a local government area, and that should be the criteria — allowing the local council to decide that, not infrastructure NSW.

"I think it needs to be a more transparent process. It needs to be tighter in terms of its direct connection to supporting local governments ... not diverting funds away to state projects."