Bank Dhofar and Bank Sohar are discussing the possibility of merger, according to a bourse filing.

Combined, the lenders are expected to have around $10bn in assets, creating the second largest bank in the country. Bank Muscat is currently the largest bank, followed by National Bank of Oman and Oman International Bank.

The potential merger is “subject to interest of other party, satisfactory due diligence and subject to obtaining shareholders’ approval and regulators’ approvals”, it said.

Banks in the region are encouraged to merge in order to create larger entities better able to cope with shocks, as regulatory changes are forcing them to have larger amounts in their capital reserves. Oman’s conventional banks are also increasingly facing competition from Islamic banks.

In Bahrain, several smaller lenders are exploring opportunities to merge. Bahrain-based Al-Salam Bank and BMI Bank, an associate of Bank Muscat, announced in May they are planning to combine their strengths to form the third largest bank in the country.

The Middle East recorded a substantial increase in banking mergers and acquisitions (M&A) deals last year, rising from $1.5bn in 2011 to nearly $7bn in 2012, according to the UK’s PricewaterhouseCoopers.