Emirates NBD is to take control of Dubai Bank, five months after the Islamic lender was rescued by the emirate's government.
The acquisition follows an order announced yesterday by Sheikh Mohammed bin Rashid, Vice President of the UAE and Ruler of Dubai.
The move was "in line with Dubai Government efforts to enhance the banking sector in the emirate", the Dubai Government Media Office said.
Dubai Bank is the most recent casualty of a lending crisis that has left banks across the UAE with large quantities of bad debt.
Money set aside by banks for defaulting debtors reached Dh49.2 billion (US$13.39bn) in August, a 32.2 per cent increase from a year earlier, according to the latest data from the Central Bank.
Shares in Emirates NBD fell 1.58 per cent to Dh3.74 after the announcement was made, single-handedly wiping out the gains seen in early trading on the Dubai Financial Market General Index, on concern the bank would be saddled with bad loans.
The acquisition of Dubai Bank by Emirates NBD, the UAE's biggest bank by assets, will allow the rescuer to stabilise the stricken Islamic lender, said Rick Pudner, the chief executive of Emirates NBD.
"This sends a very positive signal to investors in the market," he said. "It's a clear indication that the Government of Dubai is very much determined to strengthen the financial marketplace here."
Declining to name a specific price for the transaction, Mr Pudner added that Dubai Bank would be acquired at "fair value" in a deal that would not worsen its bad-loan position.
"Dubai Bank will be capitalised by Emirates NBD," he said. "This will have a negligible effect overall on the group's capital ratios."
The acquisition of Dubai Bank would increase the size of Emirates NBD's balance sheet by about Dh14bn, including liabilities of about Dh10bn, said Surya Subramanian, Emirates NBD's chief financial officer.
Mr Pudner said Emirates NBD would seek "synergies" between its Sharia-compliant subsidiary Emirates Islamic Bank and Dubai Bank, although there were no plans to merge the two lenders. The banks expect to complete the acquisition by the end of this year.
The Dubai Government rescued Dubai Bank in May and injected an unspecified amount of capital to steady its finances and protect depositors.
Prior to Dubai Bank's rescue by the emirate, it was 70 per cent owned by an arm of Dubai Holding, the conglomerate owned by Dubai's Ruler which is currently attempting to restructure its debts.
The remainder of the shares were owned by the Dubai developer Emaar Properties. The second-quarter net profit of the builder of the Burj Khalifa fell 68.8 per cent as the company wrote off its Dh172.3m stake in Dubai Bank.
Dubai Bank, which has not released financial statements since 2009, reported a loss of Dh290.6m that year, driven by write-downs of Dh544.9m on financial assets, investments and bank balances.
Emirates NBD is likely to have sufficient capital reserves to absorb any losses on bad debts held by Dubai Bank, said Khalid Howladar, a senior credit officer at Moody's Investors Service.
"If [Dubai Bank] were to be operated on a stand-alone basis, it would need to be recapitalised, given the kind of impairments that we estimate are there," he said.
Dubai Bank's loan book is likely to have deteriorated as a result of previous lending to its former parent, Dubai Group, which is seeking to restructure its own debts, Mr Howladar said.
"It's very likely that they have some related party exposure to their parent, Dubai Group or other Dubai Holding entities," he said. "Given the announced restructurings, it's very likely that they've got a high level of impairments, and that's what necessitated some additional government support."