The finance ministry is looking at the possibility of merging at least five state-run banks - from Andhra Bank, Bank of Maharashtra, Dena Bank, Punjab & Sind Bank, Vijaya Bank, and United Bank of India - with larger PSUs after their performance and bad asset levels improve.
The move has been recommended by the Working Group on Consolidation and Restructuring of PSBs (public sector banks).
Officials said smaller banks would be merged with larger banks, which needed a presence in regions where the smaller banks were strong.
The drive to create larger Indian banks stems from the need to comply with new Basel norms that would kick off by 2018 and create large entities capable of taking on competition from foreign banks with the opening up of the domestic financial sector.
Banks will need to raise almost Rs 4.5 lakh crore in Tier-1 capital, including Rs 2.4 lakh crore in equity capital, by March 2018 under the Basel III norms.
Officials said at present the focus would be on assessing the loan portfolios of small banks to help them exit businesses where they were not strong or were unprofitable. Subsequently, these banks would be asked to concentrate on particular segments.
"A re-assessment would be done and then a best-fit marriage might be looked at," said officials.
Earlier, the government had merged the State Bank of Hyderabad with the State Bank of India. There was also a move to merge some of the other SBI subsidiaries with the State Bank of Patiala seen to be next in the queue.
However, officials said such moves could take place only when the bank boards felt they were ready. Officials said the North Block would be studying various proposals for mergers among PSU banks.
"We would like banks that have branches in the south to merge with a bank with most branches in the north. However, issues such as a bank's work culture and level of integration will have to be taken into consideration before pressing for such mergers," an official said.
Besides Basel, domestic banks need to merge or organically grow into larger entities in the long term before the financial market is opened up to foreign banks.
US and European countries have long been demanding greater access to the Indian financial market in return for concessions in the services sector.
Officials said the next round of global trade talks as well as several free-trade pacts being negotiated would see demands for the opening up of the financial sector.
The government has in the past toyed with the idea of merging the associates of the State Bank of India with it or creating an "SBI-2" by merging some of these associates. Some associates such as the State Bank of Indore were merged with the SBI in the past.
The smaller unlisted subsidiaries are almost 100 per cent owned by the SBI and merging them should not pose any major problem as their functioning is similar to that of the parent.
The move, officials said, will create a larger SBI, giving the country's largest bank much more financial muscle.
Loss-making PSU banks have been similarly merged with the profitable ones to create larger entities.To nudge the banks, the government has already decided that only profitable banks with a good performance record will be recapitalised.
A provision of Rs 9,555 crore has been made this fiscal for the recapitalisation of PSU banks, including the National Bank for Agriculture and Rural Development, the Export-Import Bank of India, India Infrastructure Finance Company and Small Industries Development Bank of India.
Last year, a provision of Rs 11,200 crore had been made for recapitalisation, but a mere Rs 6,990 crore was infused into banks, including the SBI, Bank of Baroda, Punjab National Bank, Canara Bank and Syndicate Bank.
However, officials cautioned that mergers and acquisitions can be brought about only if trade unions agreed to go along as agitations and strikes might affect operations.