Jaitley said the merger would create a sustainable mega-bank which would be third largest in the country.
Jaitley also clarified that no employee will face any service conditions which are adverse in nature.
The merger announcement is a clear signal that consolidation of public sector banks (PSBs) remains on the government's agenda, and if this merger goes well, in all likelihood, further consolidation could be seen in the PSU banking space.
The move follows top lender State Bank of India past year merging with itself five of its subsidiary banks and taking over Bharatiya Mahila Bank, catapulting it to be among top 50 global lenders.
Bank of Baroda shares saw their steepest fall in over three years, according to a report by news agency Reuters. Rather, the merger of two strong banks and one weak bank seemed to be a more viable option, keeping in the mind the long-term sustainability of the merged entity and the potential for expansion. "Meanwhile, given persistent structural challenges facing mid-sized banks, we continue to maintain our cautious stance (despite trading gains in the immediate term)", said Edelweiss Securities in a recent note to its investors. The government had made a mention of consolidation of banks earlier, Jaitley said. Till then, the three banks will carry on functioning independently.
Unsurprisingly, BoB share price plunged a whopping 16 per cent to Rs 113.45 in Tuesday's trade, while Dena Bank hit upper circuit of 20 per cent, and Vijaya Bank settled at Rs 56.40, down 5.69 per cent.More news: India's Iran Oil Purchases to Fade Ahead of US Sanctions
However, FM did not talk about the name of the new entity and said that it will be revealed later.
Since the government is a majority owner in all three banks, it seems more likely than not that the merger will be approved. The Bank of Baroda's bad loan ration now stands at 12.4 percent.
The problems plaguing India's public sector banks are well known.
This is not the first time a bank amalgamation process has taken place.
"This was accompanied by sweeping the NPAs below the carpet so that the real picture doesn't come out", Jaitley added. The banking industry was saddled with bad loans - called non-performing assets in banking parlance - of Rs 8.50 lakh crore.
Pointing out that indiscriminate lending during 2008-14 was the reason for the weak health of the banking sector, the finance minister said various steps taken by the government have started showing results.