Speaking on the "Changing dimensions of supervision and regulation" at the 21st Bank Economists' Conference, Talwar urged banks to "seriously examine" measures like introduction of volutantary retirement schemes (VRS), reduction in short-term interest rates and closure of loss-making units.

Reacting strongly to Talwar's suggestions of mergers between old private sector banks, United Western Bank chairman PN Joshi said: "Don't make the old banks the sacrificial goat in the merger game." Banking secretary CM Vasudev was, however, quick to retort saying: "At certain stage, there has to be a goat which will turn into a sacrificial lamb."

The RBI deputy governor in no uncertain terms said: "the days of soft options are over" and if banks fail to tackle the problems over the next few years, they (the problems) willpose a formidable challenge to the system.

Announcing that "the public sector banks cannot continue to look to the government for the additional capital contributions," Talwar said the funds for meeting the enhanced capital adequacy ratio must come from banks' own internal accrual or by raising resources from the capital market.

Making a strong pitch for mergers, Talwar said: "Globally, banks have moved towards consolidation by the process of mergers and acquisitions. The mergers abroad have taken place amongst some of the strongest banking institutions and the underlying motivation has been to provide synergy to the operations and exploit core competencies for operational earning and profits."

In the Indian context, old private banks may be left with no choice but to take the merger route to enhance their capital bases. "The old private sector banks have low capital base. With an enhancement of the capital adequacy ratio, there is an urgent need for theser banks to augment their capital base. Onealternative is to issue fresh shares... If they are unable to enhance their capital base, it may be necessary to think in terms of mergers between the private sector banks, to start with," Talwar said.

The RBI deputy governor also told the banks to put in place an appropriate investment policy in regard to the non-SLR portfolio. "Data indicate that a sizeable portion of such investments of banks is in unquoted shares. The banks must therefore put in place an appropriate policies on non-SLR investments and keep a close watch over the valuation and liquidity of such investments," he said.

Expressing his concerns about banks not paying adequate attention to the market risk, Talwar said: "As investments form 40 to 50 per cent of the total assets, it is time that banks started paying equal attention to market risk attendant on their investment portfolio and more so in regared to non-SLR investments."