Having recently swept Bihar and now in a politically impregnable position in Parliament, the Modi government is turning its attention to a long-pending issue relating to the banking sector. It is said to be tinkering with a blueprint to complete the final phase of the ambitious but stalled public-sector bank (PSB) consolidation. The plan under consideration could reduce the number of state-owned lenders from 12 to just four in the coming financial year – the big ones being State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BoB) and a merged Canara Bank-Union Bank structure. The smaller banks will first be merged into the bigger ones and then consolidated further to form large entities capable of supporting India’s growth needs.
Under the plan, the government is moving towards the merger of Canara Bank and Union Bank of India, a consolidation expected to form one of the four surviving entities. Indian Bank and UCO Bank are also being considered for integration into the same structure, creating another large bank that will join SBI, PNB and BoB as the remaining core lenders
Other mid-sized banks – including Indian Overseas Bank (IOB), Central Bank of India (CBI), Bank of India (BoI) and Bank of Maharashtra (BoM) – are expected to be absorbed by SBI, PNB or BoB. Punjab & Sind Bank may also be merged with one of the four, depending on the final contours.
There have been several suggestions emerging from within the government on the way forward for the public sector banks. The Niti Aayog, in a report, has suggested that the government should privatise or restructure smaller banks like the Canara Bank and the Indian Overseas Bank. The think tank, however, feels that the government should retain ownership of PNB, BoB, Canara Bank or SBI. The rest of the smaller banks could either opt for privatisation, mergers or reduction of government stake in them.
Officially, of course, the government maintains that there is at present no proposal on merger or consolidation of state-owned banks before the government. This position was reiterated by Pankaj Chaudhary, minister of state for finance, in a written reply in the Lok Sabha recently. This could be because the proposal is being shaped within the finance ministry. The consolidation plan will first be placed before the finance minister for approval. Once cleared, it will enter a multi-layered vetting process that includes inputs from senior officials at institutions. The Cabinet Secretariat, examination by the prime minister’s office (PMO) and regulatory comments from the Securities & Exchange Board of India (Sebi), given the market implications.
A record of discussion will be prepared and escalated in phases. Only after the FM’s approval will it move to the Cabinet and the PMO. Sebi’s observations will also be sought, according to sources in the know of things.
Strengthening balance sheets
These sources also hinted that there is no formal commitment from the government on this issue because ‘silence pre-empts controversy.’ Bank unions, especially in the public sector, are still quite powerful, capable of organising nationwide strikes that disrupt services and heavily influence negotiations on wages, staffing and policy changes, though their power is challenged by increasing contractual hiring and internal leadership issues.
For the government, however, the idea behind the plan is to strengthen balance sheets, improve operational efficiency and create globally competitive banking institutions. The government expects the restructuring to be a key step in preparing the banking sector for rising credit demand and targets a sustained high growth. Larger, stronger PSBs are seen as better positioned to undertake big-ticket lending, support infrastructure financing, and compete with private banks that have expanded aggressively in recent years.
Officials also argue that consolidation will help rationalise branch networks, reduce overlapping costs and improve capital utilisation across the system. The government believes this round of mergers will be smoother because “larger banks now have better governance structures, stronger balance sheets and more mature integration systems,” according to the source.
If implemented as planned, the 2026-27 roadmap would mark the second major phase of PSB consolidation after the 2017–2020 restructuring, which brought down the number of state-owned banks from 27 to 12.
In April, 27 PSU banks were consolidated into 12 large entities. Reports of another major PSU bank amalgamation exercise have been doing the rounds since then. This was stated to be part of the quest to create a set of big, world-class banks that will power India’s growth. Though Finance Minister Nirmala Sitharaman stated that amalgamation was only one of the options to create scale and the important aspect was the creation of a dynamic ecosystem, consolidation looks inevitable, just as it happened in 2020.
But the government is cautious as the outcome of the previous consolidation exercises has been anything but remarkable. Earlier, in 2017, SBI had absorbed its associate banks and created a monolithic entity, ostensibly to achieve economies of scale and rationalise risk across the SBI system. But post-merger, SBI’s asset quality indicators actually deteriorated, with gross NPAs rising and net profits declining.
It is not known if a review of the 2020 consolidation has been done, but a quick look will show that, though the overall sector has done well, PSU banks have lagged behind.
• Overall bank credit grew at a CAGR of 12 per cent, while PSU banks grew at only 8 per cent.
• Though their gross NPAs nosedived steeply by 16 per cent, this was more on the back of write-offs than recoveries, and PSU banks were making losses from 2017 until 2020.
• Their combined assets at R1.95 lakh crore now form about 55 per cent of the banking sector, but the creation of world-class banks seems far away.
Even if we accept the rationale of creating world-class banks, the timing is intriguing, especially only five years into the earlier amalgamation, which had yet to demonstrate any clear benefits. Some suspect that the inspiration has come from an IMF-World Bank report. The Financial Sector Assessment (FSA) report 2024 by the IMF-World Bank combine makes some pointed suggestions in this regard. While positive about the resilience and diversity of the Indian financial system, it highlights a few disconcerting features: one, the role of the state is diminishing; two, the role of non-banking actors is increasing.
The FSA report says banks are now resilient, and even the banking sector distress of 2016 was due to defaults by power and infrastructure companies and not related to macro financial conditions. This may be true since the power sector was beset with known problems – regulatory, coal and the health of distribution companies, to name a few, while roads were saddled with PPP issues, regulatory delays and tariff issues.
But the larger point is that the PSU banks perhaps were forced into infrastructure due to the absence of specialised term lending institutions, such as the IDBI and the ICICI, and the government’s push for infrastructure. Even without the macro-economic issues, banks were clearly ill-suited for the job, given their asset-liability profiles and the lack of project appraisal skills.
Genuine concerns
The report believes that the problem of funding infrastructure has not gone away but has only shifted from banks to NBFCs. This is a concern because the increasing exposure of large state-owned infrastructure financing companies could spill over to banks, on whom NBFCs are still dependent. But lacking many of the regulatory guardrails that banks had, NBFCs are more vulnerable. The WB-IMF’s concerns may be genuine, but the solutions may not necessarily lie in tightening regulations for NBFCs.
In fact, the refrain of the report seems more about NBFCs than banks, because in the seven years since the last report, non-banks have come to finance almost half the credit to the private sector. The worry was that NBFCs were on shakier grounds, and macro scenario solvency tests masked critical vulnerabilities from concentration risks to the power sector. The fact that NBFCs’ liquid assets were only a little over 5 per cent of total assets gave rise to fears that the next systemic liquidity event could arise from NBFCs.
Banking experts feel that a point that the report perhaps misses is that this was not a case of NBFCs rushing in where banks feared to tread, because these state-owned NBFCs had existed a long time before they became RBI-regulated NBFCs and had been set up specifically to finance infrastructure projects.
The other important feature of the report is about the role of the state. It has specific prescriptions in this regard relating to capital, priority sector lending, regulations and even the IBC code. It wants the state to redefine its role, reduce its footprint to increase efficiency and mobilise private capital. It says the government had spent 1.1 per cent of 2023 GDP ($38.8 billion) to recapitalise 21 PSBs from 2017-18 to 2020-21, but got little in return.
A far-reaching recommendation is on the privatisation of select PSBs and insurance companies by increasing private ownership and removing the 20 per cent foreign investment cap. It also wants the exemptions for state-owned NBFCs from some of the prudential standards to go. These are all known problems, but then our financial system architecture is a legacy issue.
Low income and low savings necessitate a large role for the state, but also limit the potential for taxation, which means large borrowings to fund the state. Large debt requires a large base of subscribers, a role which banks have been playing, but at the cost of pre-empting long-term savings in favour of the government, leaving little scope for debt or bond markets.
Raghuram Rajan called it a grand bargain where, in return for capital, low-cost funds and safety, banks would subscribe to government securities, lend to priority sectors and open branches.
The rationale for more mergers at this stage is not convincing; perhaps, the government is now beginning to see some of the limitations of the model. With likely increased demands for capital that could arise after the new Basel ECL (expected credit loss) regime, the low returns on equity and the impact on private savings, the urge to merge may well be the first of the steps to exit the system, though that could take a long time.
While size and scale undoubtedly matter in the global financial order, the real strength of a bank ultimately lies in its people. Employee morale, motivation and cultural integration are as vital as capital adequacy and technology upgrades in ensuring that merged entities truly succeed.
A long episode
In this context, one needs to recall the first post-nationalisation merger in 1993, when Punjab National Bank (PNB) absorbed the New Bank of India – a move aimed at rescuing the latter from mounting losses. What appeared to be a straightforward administrative action soon turned into a prolonged episode of organisational turbulence.
Employees of the erstwhile New Bank of India, which had a strong union and close ties with its management, struggled to adjust to the new environment. Also, differences in work culture, privileges and perceived loss of influence created deep resentment.
Litigation followed, industrial peace was disturbed, and the combined bank struggled for years to regain normalcy. For nearly three years, no internal promotions took place. The episode became a cautionary tale of how mishandled human integration can undermine even a well-intentioned merger.
For almost two decades thereafter, no major PSB merger occurred. But then in the 2000s, the SBI absorbed its associate banks. While the move created a banking powerhouse with global scale, employee integration proved far more difficult. Even after a decade, many staff members of the erstwhile associate banks continue to feel undervalued within the larger structure. The lesson was clear: a legal merger is not the same as an emotional merger.
Indeed, the government will have to contend with the muscle-flexing by powerful trade unions. This was evident when the government recently decided to open top-level posts in state-owned financial sector entities – banks and insurance companies – to private sector candidates, the United Forum of Bank Unions (UFBU) strongly protested the move, terming it ‘a de facto privatisation’ of leadership in statutory public institutions. The orders enabling such appointments were issued without any amendment to the enabling statutes – namely the State Bank of India Act, 1955; the Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970 and 1980; and the Life Insurance Corporation Act, 1956 – and, therefore, constitute ‘a serious legal and constitutional transgression’, UFBU said in a statement. The UFBU represents nine trade unions of officers and workmen across banks.
Despite challenges, the logic for consolidation remains compelling. Larger banks enjoy economies of scale, stronger capital buffers and wider geographic reach
The executive orders issued by the Appointments Committee of the Cabinet on 4 October 2025, approved ‘revised consolidated guidelines’ for the appointment of whole-time directors (WTDs), managing directors (MDs), executive directors (EDs) and chairpersons in public sector banks (PSBs), including SBI and in public sector insurance companies. But, “public sector banks are not merely financial institutions,” the UFBU carped; “they signify national trust, serving every section of society and anchoring financial inclusion. These are statutory and important public financial institutions, and their leadership carries a sovereign and fiduciary responsibility to the people of India, not merely a corporate mandate.”
Despite such challenges, the logic for consolidation remains compelling. Larger banks enjoy economies of scale, stronger capital buffers and wider geographic reach. They can fund big infrastructure projects, invest in digital transformation and compete with private and global peers. For policymakers and regulators, having a few well-capitalised PSBs is easier to supervise and recapitalise than managing dozens of small, unevenly governed entities.
Globally too, banking systems in countries such as China, Japan and South Korea are dominated by a handful of mega banks that drive growth and innovation. However, the government will have to keep in mind the fact that every merger involves more than the blending of balance sheets – it is a fusion of cultures, histories, and aspirations.
The government will have to keep in mind that mergers do not just combine assets – they combine people. A well-integrated, inspired workforce can transform even a modest-sized bank into a powerhouse of performance, while a demoralised one can sink the mightiest of institutions.