The Indian government is reportedly gearing up for a fresh round of consolidation among public sector banks (PSBs). This initiative, coming five years after the last major merger exercise reduced the number of state-owned lenders from 27 to 12, aims to forge fewer, larger banking behemoths. The goal is to create institutions with the balance-sheet heft of global banks, capable of financing India's massive infrastructure and credit needs. However, this push for scale brings with it a critical dilemma: the risk of concentrating too much financial power in a handful of mega-lenders, potentially amplifying systemic vulnerabilities.
The Global Scale Gap and the Rationale for Mergers
Despite having a deep and expansive domestic network, India's banking system remains modest on the global stage. Only two Indian banks, State Bank of India (SBI) and HDFC Bank, feature among the world's top 100, ranking 43rd and 73rd respectively. In stark contrast, China dominates with 21 banks in the top 100, including seven in the elite top 20. The asset gap is even more pronounced. SBI's balance sheet stands at approximately $0.85 trillion, while China's Industrial and Commercial Bank of China (ICBC) manages a colossal $6.7 trillion in assets. Even large US banks like JPMorgan Chase operate with asset bases 3-4 times larger than their Indian counterparts.
This scale deficit has tangible consequences for India's ability to fund large-scale industrial and infrastructure projects independently. The government's merger plan seeks to address this gap at an opportune time. PSBs are currently in their strongest financial health in years. In the 2024-25 fiscal year, they recorded a net profit of ₹1.78 trillion, supported by cleaner balance sheets and a gross non-performing asset (NPA) ratio at a decade-low of 2.6%. For the first time in over ten years, PSBs also outpaced private banks in loan growth, posting a 13.1% year-on-year increase. This robust health provides a stable foundation for consolidation, reducing the risk of a weak bank dragging down a stronger partner during integration.
Lessons from Past Mergers and the Efficiency Question
A Reserve Bank of India (RBI) study of 17 bank mergers between 1997 and 2017 offers insights into potential outcomes. The analysis shows that post-merger gains were most consistent in strengthening balance sheets. Key ratios like capital adequacy improved in over 80% of cases, and credit deployment metrics strengthened in roughly 70% of acquirers. This indicates that mergers can effectively bolster a bank's capacity to lend and absorb losses.
However, the picture on operational efficiency and profitability is mixed. While some cost metrics improved, the broader cost-to-income ratio strengthened in only one-third of mergers, suggesting that realizing synergies takes considerable time. Profitability, measured by return on assets and equity, improved for only about half the banks studied. This underscores that scale does not automatically translate to higher earnings, and the integration process itself is complex and prolonged.
The Systemic Risk Amplifier: The "Too Big to Fail" Conundrum
The most significant concern surrounding the creation of mega-PSBs is the escalation of systemic risk. Banking consolidation risks creating institutions deemed "too big to fail." The RBI's own financial stability simulations paint a worrying picture. According to the latest Financial Stability Report, the hypothetical collapse of a single large bank could wipe out 3.4% of the entire banking system's tier-1 capital, the core equity buffer that protects depositors. The failure of a second major bank could erode a further 2.2% of system capital and push another lender into liquidity stress.
Large banks are deeply interconnected through lending, borrowing, and settlement channels, meaning distress in one can send shockwaves throughout the financial network. India already designates SBI, HDFC Bank, and ICICI Bank as Domestic Systemically Important Banks (D-SIBs), subjecting them to higher capital requirements. Further mergers could see more PSBs entering this category, increasing concentration and the network's vulnerability to a single point of failure.
The Concentration Conundrum: Is Merger the Only Path?
As India contemplates this path, a fundamental question arises: are fewer, bigger banks the only route to achieving global scale? The experiences of the world's largest banking systems suggest alternative models. The United States, for instance, boasts an ecosystem of over 4,500 banks, which prevents giants like JPMorgan Chase from dominating the landscape entirely. Similarly, China has built a layered structure with city commercial banks, rural cooperatives, and policy banks thriving alongside its national champions.
India currently has 135 scheduled commercial banks, including PSBs, private, foreign, and regional lenders. The top three already command about 41% of total assets—a share that will inevitably rise with consolidation. The challenge for policymakers will be to strike a delicate balance: creating the scale needed to fuel India's growth ambitions while preserving enough diversity in the banking system to mitigate systemic risks and ensure that regional and sectoral credit priorities are not diluted in the pursuit of size.
The success of this renewed consolidation push will hinge on meticulous execution, robust regulatory oversight, and a clear-eyed assessment of whether the benefits of creating global-sized lenders truly outweigh the amplified risks of a more concentrated financial system.
