Bigger Banks, Better Governance? What PSB Consolidation Actually Delivered

In August 2019, the finance ministry announced the merger of ten public sector banks into four, consolidating Punjab National Bank with Oriental Bank of Commerce and United Bank of India, Canara Bank with Syndicate Bank, Union Bank of India with Andhra Bank and Corporation Bank, and Indian Bank with Allahabad Bank, completing a wave of public sector bank consolidation that had begun with State Bank of India's absorption of its associate banks in 2017. The stated rationale was straightforward: India had too many small and mid-sized public sector banks, many of them under-capitalised and struggling under the weight of non-performing assets accumulated through the mid-2010s corporate lending stress that came to be known as the twin balance sheet problem, and scale would allow the merged entities to compete more effectively, absorb losses more comfortably, and reduce the fiscal burden of repeatedly recapitalising a dozen separate weak banks individually.

Five years on, the balance sheet turnaround has been genuinely dramatic. Gross non-performing asset ratios across public sector banks have fallen from peaks above 14-15 percent in 2017-18 to below 4 percent in recent RBI Financial Stability Reports, public sector banks have returned to consistent profitability after years of losses, and several, including State Bank of India and Bank of Baroda, have posted record profits in recent fiscal years. The government has, understandably, pointed to consolidation as vindicated by these numbers.

Separating consolidation's effect from the broader recovery

The harder analytical question is how much of this improvement is attributable to consolidation itself versus a broader set of contributing factors that would likely have improved bank balance sheets with or without mergers. The Insolvency and Bankruptcy Code, introduced in 2016, gave banks a considerably more effective legal mechanism for recovering value from defaulting corporate borrowers than the earlier, notoriously slow debt recovery tribunal system, and recovery rates and resolution timelines under the IBC, while still slower than the code's original ambitions, represent a genuine structural improvement in banks' ability to clean up bad loans. The broader economic recovery post-pandemic, corporate deleveraging that many large Indian companies undertook independently after the mid-2010s stress, and successive rounds of government recapitalisation, injecting well over 3 lakh crore rupees into public sector banks between 2017 and 2021 through recapitalisation bonds, all contributed substantially to the sector's turnaround independent of whether any specific bank had been merged with another.

Disentangling these effects cleanly is difficult, but RBI and academic analyses of the merger's specific effects have generally found more modest, incremental efficiency gains, some reduction in duplicate branch networks and back-office costs, some improved ability to absorb credit risk through larger capital bases, rather than the transformative effect the initial merger announcement implied. This does not mean consolidation was pointless, but it does suggest the recovery narrative attributes to mergers specifically a good deal of credit that likely belongs to the IBC, recapitalisation and the macro cycle instead.

The governance problem the mergers didn't touch

The more serious limitation of the 2019-20 consolidation is that it addressed scale and balance sheet size without meaningfully addressing the governance weaknesses widely identified, including by the RBI's own past reports and by the P.J. Nayak Committee back in 2014, as the deeper root cause of the bad loan crisis in the first place. The Nayak Committee had argued forcefully that public sector bank governance suffered from excessive government ownership control over board appointments, chief executive tenures too short to support long-term strategic decision-making, inadequate board expertise and independence, and a culture in which lending decisions, particularly to large corporate borrowers, were vulnerable to political influence or at minimum to a risk-averse bureaucratic caution that produced its own distortions.

The Banks Board Bureau, created in 2016 partly in response to the Nayak Committee's recommendations to professionalise senior public sector bank appointments and insulate them from direct political discretion, has had a mixed record and was itself restructured into the Financial Services Institutions Bureau in 2022, with the change reflecting continued institutional uncertainty about how much genuine independence from the finance ministry such a body should or does have in practice. Chief executive tenures at public sector banks, while somewhat lengthened compared to the extremely short tenures of the mid-2010s, remain shorter on average than at well-run private sector banks, limiting the ability of a public sector bank's leadership to pursue multi-year strategic transformation with confidence that they, rather than a successor, will be accountable for its outcomes.

Board independence and continued government stake

The Union government retains majority ownership in all public sector banks even after consolidation, and finance ministry officials continue to sit on public sector bank boards and are involved, to varying degrees across different banks and time periods, in decisions ranging from large loan approvals to senior appointments. This is not unique to India among countries with significant state-owned banking sectors, but it does mean the specific governance vulnerability the Nayak Committee identified, decision-making shaped by considerations other than pure commercial credit risk assessment, has not been structurally eliminated by making the banks larger. A larger bank with the same governance architecture is simply a larger institution exposed to the same categories of risk, with a correspondingly larger potential fiscal exposure if governance failures recur.

What genuine reform would still require

Economists and former RBI officials who have studied public sector bank governance, including former governor Raghuram Rajan, have periodically argued that the more consequential reform India has avoided is reducing government ownership stakes below majority levels in at least some public sector banks, which would allow genuinely independent boards with market-standard governance structures, executive compensation and accountability mechanisms, free from the specific constraints that come with being a government-controlled entity subject to Right to Information disclosure requirements, Central Vigilance Commission oversight, and Comptroller and Auditor General audit that, whatever their value for public accountability, also create risk-aversion incentives among bank officials wary of decisions being second-guessed years later by an auditor without full context of the commercial judgment involved at the time.

Consolidation as a partial reform

The fair verdict on public sector bank consolidation is that it achieved real, measurable gains in balance sheet resilience and modest efficiency improvements, while leaving largely untouched the governance architecture that most credible analyses, including the government's own commissioned reports, identified as the deeper cause of the crisis consolidation was partly meant to resolve. That the banking sector currently looks healthy owes at least as much to a favourable macro cycle, IBC-enabled recovery, and substantial recapitalisation as to the mergers themselves, and that favourable cycle will not last indefinitely. Whether public sector banks can navigate the next credit cycle downturn without repeating the mid-2010s pattern will depend far more on whether governance reform eventually catches up to the consolidation exercise than on how many banks currently share a single balance sheet.