Bank of Scotland and the Halifax UK mortgage bank are in advanced negotiations on a £26 billion sterling (€42 billion) merger to create the UK's fifth largest bank.

The merger will introduce the Halifax into the Republic for the first time and could prompt National Australia Bank - which owns National Irish Bank and Northern Bank - to consider a merger with AIB or Bank of Ireland as its options for consolidation in the UK market narrow.

Bank of Scotland, which owns ICC Bank, already offers mortgages in the Republic and will have to decide whether to continue selling under its own name or to introduce the Halifax brand here. Halifax is already a dominant player in the mortgage market in Northern Ireland and has announced plans to open a call centre there.

There is very little overlap between the operations of the two banks, with Bank of Scotland dominant in the small business banking sector and the Halifax dominating the mortgage market and it is unlikely to have any immediate implications for the Irish operations.

News of the talks took the market by surprise yesterday with some analysts expecting that NAB may yet launch a rival bid for the Halifax. NAB is searching for acquisitions in the UK market to consolidate its position in that market. If the Bank of Scotland and Halifax deal goes ahead NAB's options will be radically reduced. A merger between Abbey National and Lloyds TSB is currently before the UK competition authorities, leaving a few smaller players in that market. Some analysts suggest NAB could now be forced to consider a merger with Bank of Ireland or AIB to realise its expansionary ambitions.