The government is considering a two-pronged strategy to further consolidate public sector banks (PSBs) – merging smaller lenders to create scale and gradually diluting its ownership closer to 51% to enable the banks to raise growth capital independently.
According to sources familiar with the discussions on the matter, this mix of consolidation and calibrated dilution of government’s stake is essential to build banks capable of funding the expanding credit needs of a fast-growing economy.
In the next consolidation cycle, the focus is expected to be on the five smallest PSBs by asset size, which may be merged with mid-sized banks to make them more comparable with the country’s larger state-run lenders. State Bank of India (SBI), that is already far ahead of other PSBs in terms of size and reach of operations after absorbing its associate banks, is unlikely to be part of the new round of consolidation.
Multiple merger combinations are under examination, though no specific banks have been identified yet, the sources said. The Union Budget 2026-27 is expected to offer policy direction on the future course of PSB reforms, they said.
Consolidation 2.0
Lessons from earlier consolidation exercises are shaping the current thinking. The previous mergers, particularly those executed in 2019-20, were far from smooth, marked by IT integration challenges, branch overlaps and staff rationalisation issues. In several cases, banks with similar regional footprints were merged, resulting in duplicated branch networks and employee redeployment problems.
Industry watchers argue that future mergers should be designed to avoid combining banks headquartered in the same region, thereby minimising operational disruption. The merger of Oriental Bank of Commerce with Punjab National Bank – both with a strong northern India presence – is often cited as an example of how overlapping geographies intensified integration challenges.
Attracting Capital
Alongside consolidation, officials believe reforms must address capital constraints faced by PSBs. One proposal gaining traction is to raise the foreign direct investment (FDI) limit in PSBs from the current 20% to as much as 49%, allowing these banks to tap long-term global capital. In contrast, private sector banks are permitted up to 74% foreign ownership.
However, ownership limits alone may not be enough to attract serious investors. While shareholders in private banks can exercise voting rights of up to 26%, investors in PSBs are restricted to just 10% voting power, even if they hold a 20% equity stake. This imbalance has discouraged large institutional and strategic investors from acquiring meaningful stakes in state-owned lenders. That explains why foreign holding in India’s largest bank, SBI, is just 10.64% now, and it is even less than 1% in smaller PSBs.
Officials argue that FDI limits and voting rights in PSBs should be aligned more closely with those in private banks, while still ensuring government ownership of at least 51%. Such alignment, they believe, would make PSBs more attractive to patients, long-term investors without compromising public control.
The reforms debate extends beyond PSBs. Raising voting rights in private banks is a long-standing demand from promoters and institutional investors. The voting rights cap in private banks was last raised from 10% to 26% through the Banking Laws (Amendment) Act, 2012. Both the Reserve Bank of India (RBI) and the government have historically opposed removing the cap altogether, citing concerns over governance, public trust and concentration of ownership.
Yet, large domestic and foreign investors argue that the disconnect between economic ownership and voting power discourages capital infusion. Any change, however, is likely to be cautious and incremental.
The renewed push for reform comes after a six-year pause in consolidation and reflects the government’s ambition to create two Indian banks capable of entering the global top 20 by assets. Officials are working on a reform roadmap that could be executed between 2026 and 2028.
As of March 2025, SBI remains the clear leader with assets of `66.76 lakh crore, followed by Punjab National Bank (`18.18 lakh crore), Bank of Baroda (`17.81 lakh crore), Canara Bank (`16.83 lakh crore) and Union Bank of India (`15 lakh crore). At the smaller end are Central Bank of India, Indian Overseas Bank, Bank of Maharashtra, UCO Bank and Punjab & Sind Bank—widely seen as early-phase merger candidates. The approach could eventually bring down the number of PSBs from the current 12 to three or four large institutions.
The broader reform thrust centres on strengthening capital buffers, enhancing board autonomy and improving governance, including giving PSB boards greater freedom to hire talent from outside the system. Recently, the government opened MD posts in SBI and MD & CEO roles in nationalised banks to private-sector applicants.
The vision aligns with discussions during the finance ministry’s recent “Manthan” strategy exercise and builds on the consolidation wave of 2017 and 2019-20, which reduced the number of PSBs from 27 to 12. While those mergers helped clean up balance sheets and improve profitability, policymakers now see consolidation as a strategic growth lever rather than a rescue tool.