Public Sector Banks Mergers Policy and Future Directions

The banking sector in India is witnessing cautious deliberations on the future of Public Sector Banks (PSBs). Despite talks about further consolidation at the 2025 Manthan-bankers conclave, the official position remains no immediate mergers. The focus is on strengthening banks through organic growth, improved governance, and technology enhancements before considering new mergers.

Background of PSB Mergers

The large-scale PSB merger drive in recent years reduced the number of banks to 12. The main goal was to create larger banks capable of financing major infrastructure projects. This idea traces back to the Narasimham Committee II (1998), which recommended consolidating PSBs to build fewer but stronger institutions. The committee proposed a three-tier banking structure – three large banks with international reach, eight to ten national banks, and numerous regional/local banks. The current PSB framework largely follows this model.

Challenges in PSB Mergers

Mergers require blending different organisational cultures and consolidating technology and human resources. Poorly managed mergers risk disrupting customer service and operational efficiency. Previous consolidations led to closure or merging of about 4,800 branches and a net loss of 4,000 ATMs, reducing outreach. Workforce rationalisation caused a decline of nearly 78,000 employees between 2020 and 2024. Employee uncertainties on benefits and promotions often lower morale and productivity. Integration risks may dilute managerial efficiency and increase operational risks, affecting bank performance.

Strategic Importance of Mergers

Mergers aim to create banks capable of competing globally and financing large infrastructure projects. Larger banks can better manage risk and expand asset portfolios. Combining non-fund-based and funded lending can enable mega financing. However, mergers alone do not create new value unless preceded by reforms in governance, risk management, and operational efficiency.

Policy Recommendations and the Way Ahead

The government and regulators are considering alternative approaches before further mergers. Raising the Foreign Direct Investment (FDI) limit in PSBs above the current 20% cap could attract more capital without diluting government control. Adjusting voting rights for foreign investors may accompany this. Transitioning PSBs to a Non-Operative Financial Holding Company (NOFHC) model can enhance transparency and autonomy in management. Strengthening risk appetite and improving risk management are vital for handling large projects. Overall, reforms must accelerate to prepare PSBs for future consolidation.

Current Status and Outlook

The existing 12 PSBs are expected to consolidate their size and strength organically. The government emphasises a cautious approach to mergers to avoid operational disruptions. Enhanced governance, technology upgrades, and improved risk practices are the priorities. PSBs must build capabilities to compete among the top 100 global banks before any new merger phase.

Questions for UPSC:

1. Critically discuss the role of Public Sector Banks in financing infrastructure projects in India and the challenges they face in the current economic environment.
2. Examine the impact of mergers and acquisitions on organisational culture and employee morale in large public sector institutions with suitable examples.
3. Analyse the significance of Foreign Direct Investment (FDI) in the banking sector. How can raising FDI limits influence financial stability and growth in India?
4. Discuss in the light of recent banking reforms the advantages and disadvantages of the Non-Operative Financial Holding Company (NOFHC) model in managing public sector banks.

Answer Hints:

1. Critically discuss the role of Public Sector Banks in financing infrastructure projects in India and the challenges they face in the current economic environment.

1. PSBs are key financiers of large-scale infrastructure projects due to their size and government backing.
2. Mergers aimed to create larger banks capable of funding mega projects with better risk absorption.
3. Challenges include risk management complexities, asset quality issues, and limited risk appetite in volatile economic conditions.
4. Operational inefficiencies and legacy systems hamper timely credit delivery to infrastructure sectors.
5. Recent workforce reductions and branch closures have reduced outreach and customer service capabilities.
6. Need for improved governance, technology upgrades, and strengthened risk management to support infrastructure financing effectively.

2. Examine the impact of mergers and acquisitions on organisational culture and employee morale in large public sector institutions with suitable examples.

1. Mergers require blending diverse organisational cultures, often causing resistance and adjustment difficulties.
2. Employee uncertainties about benefits, promotions, and job security lower morale and productivity.
3. Workforce rationalisation leads to job losses, as seen in PSBs where 78,000 jobs were cut between 2020-2024.
4. Disruption in established regional loyalties and identity affects employee engagement.
5. Poorly managed integration can dilute managerial efficiency and increase operational risks.
6. Successful mergers need strategic planning, communication, and cultural integration efforts to minimize negative impacts.

3. Analyse the significance of Foreign Direct Investment (FDI) in the banking sector. How can raising FDI limits influence financial stability and growth in India?

1. FDI brings in capital, technology, and global best practices, enhancing banking sector competitiveness.
2. Current FDI cap in PSBs is 20% with 10% voting rights limit, restricting foreign investor influence.
3. Raising FDI limits can attract more foreign capital without diluting government majority stake (51%).
4. Enhanced foreign participation can improve governance, risk management, and innovation in PSBs.
5. However, excessive foreign control may raise concerns about sovereignty and financial stability.
6. Balanced FDI increase can support infrastructure financing and overall economic growth by strengthening banks.

4. Discuss in the light of recent banking reforms the advantages and disadvantages of the Non-Operative Financial Holding Company (NOFHC) model in managing public sector banks.

1. NOFHC model provides greater transparency and autonomy in PSB management compared to direct government control.
2. It allows separation of ownership and banking operations, improving governance and accountability.
3. Model aligns with RBI’s licensing norms for universal banks, promoting professionalism.
4. May face challenges in political interference reduction and ensuring alignment with public policy goals.
5. Transition to NOFHC requires legal and structural changes, which can be complex and time-consuming.
6. Overall, NOFHC can enhance operational efficiency but needs robust regulatory oversight to safeguard public interest.