Westpac Banking Corp Ltd, the fourth largest banking group in Australia, is in talks with smaller rival St George Bank Ltd for a possible takeover.

A successful deal could create the country's largest bank by market capitalisation and the second largest by assets. It would be Australia's largest home lender with a market share of 25 per cent.

A deal would also create Australia's largest wealth management provider with funds under management of A$108 billion.

The combined entity, with greater financial clout, would also help  generate funds at lower cost at a time of a global credit crunch, Westpac said in a statement.

A combination of Westpac, with a market value of $46 billion (A$49 billion) and St George, valued at $14 billion, would overtake Commonwealth Bank of Australia which has a market value of about A$58 billion.

Australia bars mergers among its four biggest banks. St George is the fifth largest Australian bank.

Westpack said it planned to keep the St George brands and branches.

A deal between Westpack and St George, however, could trigger larger consolidation among banks and may lead to merger of smaller banks.

Westpac's new chief executive Gail Kelly joined the bank after leaving St George in August last, where she held the CEO post for five years.

Although Australian banks are largely unaffected by the subprime-related credit woes, the global credit crunch has raised their funding costs and consequently their lending rates.

Westpac is planning an all-share deal to lower risks and costs of  acquiring St George, which has a lower credit rating than its rivals.

A merger would, however, require various regulatory approvals, including clearance from the Federal Treasurer.

St George has been struggling to raise funds in the debt market.

Westpac, which reported a 10 per cent rise in first-half net profit, expects lending growth to slow.