Merger of public sector banks — need for caution

At the 12th SBI Banking and Economics Conclave in November 2025, Finance Minister Nirmala Sitharaman said that the country needed big and world-class banks, and that discussions were on with the RBI in this regard.

That was the first official indication of the possible merger of public sector banks (PSBs), on which the official stance remains a “no immediate mergers”. Consolidation of PSBs has been going on for some time. India has already seen two major waves of mergers of PSBs: first, the SBI absorbed its associate banks in 2017, and then in 2019, 10 smaller lenders were merged into 4 larger entities, reducing their total number to only 12 from 27 in 2017.

The proposed plan, still speculative, by all indications, would reduce the number of PSBs further to perhaps 4-6 larger entities, with smaller lenders like Indian Overseas Bank, Central Bank of India, Bank of India, Bank of Maharashtra, UCO Bank and Punjab and Sind Bank likely to be absorbed into larger banks such as State Bank of India, Punjab National Bank and Bank of Baroda.

The idea is to create significantly larger PSBs capable of enhancing India’s banking stability and global competitiveness by combining resources, expertise, and infrastructure. But the Government needs to carefully examine the quantitative and qualitative impacts of these mergers, and tread the path rather cautiously.

Merging weaker banks with stronger ones is desirable only if the merged entities with larger balance sheets, deeper capital buffers and a wider network of branches can become better equipped to absorb shocks, support diversified lending portfolios, meet stricter regulatory standards, and improve efficiency to support long-term growth. Consolidation can also pool resources for digital banking, cybersecurity enhancements, and fintech integrations, which are critical needs in a rapidly digitising and evolving financial system.

The health of India’s PSBs is vastly improved now from what it was a decade back, when most PSBs were placed under the RBI’s Prompt Corrective Action (PCA) supervisory framework, triggered by poor capital base, asset quality, or soaring NPAs. In 2017-2018, there were 11 PSBs under PCA; all have now come out of it. Their performance has significantly improved, marked by record profitability (INR 1.78 lakh crore net profit in FY25), reduced NPAs (Gross NPA down to 2.31 per cent), robust credit and deposit growth, driven by reforms, digitisation, and better governance. They are the key drivers of India’s economic growth, and, undisputably, there is a case for their further consolidation to make them globally competitive and financially robust institutions capable of supporting the Viksit Bharat 2047 vision. No Indian bank, let alone PSBs, operates at a scale comparable to its global peers. While the top Indian Bank, SBI, manages assets worth only about $700 billion, the top US and European banks like JP Morgan Chase, Bank of America or HSBC manage assets worth above $3 trillion each. If this scale gap is to be bridged, consolidation is an imperative.

Our experiences in past mergers have been rather mixed. SBI’s merger with its five associate banks in 2017 was followed by integration turbulence, especially in aligning disparate IT systems and front-end processes. Likewise, the 2019-20 PSB consolidation slowed credit growth due to transitional adjustments. In both cases, post-merger efficiency gains were limited, and cost-to-income ratios did not fall as expected. Credit growth also remained slow, as banks were cautious immediately after the NPA crisis when the mergers took place. While an increase in scale improved resilience, it did not lead to immediate performance improvement.

In contrast, private sector mergers (for example, ICICI-Bank of Rajasthan, HDFC-HDFC Bank) show that mergers executed with robust organisational alignment, clear IT roadmaps, and strong governance tend to outperform those where change management is under-invested.

The private sector banks cleaned up their balance sheet before the merger, unlike most PSBs, and governance reform was a central driver of the merger, which was minimal in the case of PSBs.

The efficiency gains for private merged banks were very positive, and this teaches us a lesson that mergers are no substitutes for reform, that without changing the governance structure, mergers only compound the existing problems. Economists often apply econometric models to study the impact of transitions.  Several such models have been applied to study bank mergers and acquisitions (M&As) in the US, Europe, and also in India. There are

efficiency and cost function models that test the efficiency gains, market competition models to test market concentration, event study models to test stock market reaction, risk and stability models to check the impact of mergers on systemic risk and financial stability, dynamic panel models to study post-merger performance, etc.

These models, when applied to Indian PSB mergers post-2017, tell us that while mergers improved balance-sheet stability, capital adequacy and provisioning buffers, they did not generate statistically significant gains in profitability or efficiency in the short to medium run. Mergers did not produce enough synergies to accelerate credit growth.

Data Envelopment Analysis (DEA) and Stochastic Frontier Analysis (SFA) models show limited or no improvement in cost efficiency, and some merged entities even experienced temporary efficiency declines. Event-study models showed muted or negative market reactions, indicating investor scepticism in the absence of governance reform. All these tell us that unless mergers are accompanied by governance reforms covering board autonomy, managerial incentives and operational flexibility, productivity cannot be improved, even though mergers may improve resilience and stability. International experience also shows that bank mergers are primarily stability-enhancing tools, not automatic drivers of efficiency or growth.

Bank mergers in the USA have been driven by deregulation and crisis interventions, especially after the global meltdown of 2008. Consolidation in the USA had created “too big to fail” banks and financial institutions — they were the central transmission channels that pushed the global economy and financial system into an unprecedented crisis, which shook the entire world.  The emergence of these megabanks increased systemic risk manifold; to manage this, much tighter regulations had to be brought in. This is another lesson — mergers must be accompanied by appropriate reforms in regulation.  In the late 1980s, Japan experienced a huge asset price bubble that led to abnormal increases in prices of equities, land and real estate, to control which the Bank of Japan had to tighten the monetary policy.  As the prices collapsed, banks were saddled with enormous volumes of NPAs, and they started collapsing.

Government responded with the usual tools — public-funded capital injections, creation of asset-management companies to absorb bad loans and forced mergers leading to many of today’s megabanks (Mitsubishi UFJ, Sumitomo Mitsui and Mizuho). The mergers restored stability, but could not revive profitability and dynamism in the absence of governance reforms and a deflationary macroeconomic environment. As a consequence, Japan suffered a lost decade of low growth and deflation.

The lesson is clear and should guide our future mergers too — that reliance on mergers without governance reform may not improve performance; on the other hand, it may lead to stagnation. The lesson is all the more important for us as PSBs control over 60 per cent of our banking system in terms of both deposits and credits.

The author is a former Director General of the CAG of India, is a Professor at the Arun Jaitley National Institute of Financial Management. Opinions expressed are personal; views are personal