"Finding new business models will inevitably lead to some consolidation ... We must create at least 2 or 3 world size banks. China has done it.
"And if India wants to be ... and it will be the third largest economy in the world ... we must also have one or two world size banks and some consolidation is inevitable," he said at Bancon-2012 meet here.
Unions have been opposing mergers and consolidations in the banking space.
"We should not fear consolidation. I know there is pride and identity, but ultimately some consolidation would have to take place in the banking system in this country," he said.
He further said that while consolidation takes place among top banks, there would be room for local area banks as well.
"In fact, I regret that the idea of the local area bank which was started in 1996 stopped after first three licences were given. I think there is place for a local area bank for serving people of the region, local area, drawing strength from those people and serving those people," he added.
There are 19 nationalised banks and scores of private and foreign banks in the country. In addition there is State Bank of India, which is the largest lender in the country. It has also five associate banks.
SBI has acquired board approval for the merger of the its remaining five associates with itself. It has already amalgamated two of its subsidiaries.
The Finance Ministry had recently asked large public sector banks to hand-hold smaller counterparts to improve the latter's functioning.