To counter the problem of “too big to fail” banks, small banks must get bigger, according to bank analyst Meredith Whitney.

“One of the messages frequently lost on investors as well as operators of banks is that just as the regulators want the ‘Too Big to Fail’ banks to shrink, they need the smaller banks to get larger,” writes Whitney, CEO of Meredith Whitney Advisory Group, in an article for the American Banker.

“That is the only way to rebalance an industry that’s been imbalanced for 15 years. It would be a gift to both large and small banks.”

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This is the year for small banks “to step up to the M&A [mergers and acquisitions] plate.”

More deals are being done with both a stock and monetary component, she points out, noting that that’s goods for sellers.

“They can both monetize their ownership in often illiquid investments and retain a carried interest in what I believe will be an enormous growth market for the newly created superregional banks of the next decade.”

With M&A of large banks essentially being blocked by regulators, large banks must use what they have to improve their efficiencies rather than getting bigger for the sake of getting bigger.

That turns the traditional bank M&A world upside down. Large banks, seeking greater efficiency through scale, have historically dominated M&As.

The change will be a challenge for many banks, Whitney says. “Not only have the big banks not been accustomed to going in reverse, only a handful of them are openly accepting that the current weak revenue environment may actually be here to stay.”

A few banks have started plans to improve efficiencies and profitability.

“For others, plans are well under way and 2013 is poised to be a banner year,” she writes. “From investors’ perspective, this will be a ‘show me’ year for large bank CEOs.”

Many experts are predicting a wave of bank M&A activity over the next few years.

“We don’t believe that there will necessarily be a wave, but there is bound to be an increase in activity,” writes Charlie Crowley, managing director at investment banking firm Boenning & Scattergood, in a blog for Crain’s Cleveland Business.

“Despite decades of consolidation, there are still more than 7,000 banks in the country,” he says. An average of 263 banks a year were acquired nationwide between 2000 and 2007, compared with just 145 FDIC-unassisted deals from 2008 too 2011.

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