The government is strategizing a new round of Public Sector Bank (PSB) reforms, focusing on merging the five smallest banks and gradually diluting its ownership closer to 51%.
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.
