By Tom Sims and John O'Donnell
FRANKFURT (Reuters) - The European Central Bank will ask Deutsche Bank (DE:DBKGn) to raise fresh funds before it gives the go-ahead for a merger with a state-backed rival, a person with direct knowledge of the matter said.
The official said that Deutsche would be required to have the buffer, which has yet to be calculated, to cope should it experience setbacks while integrating Commerzbank (DE:CBKG) if a deal is agreed.
The demand could complicate a bid to create Europe's third-largest bank from Germany's top two lenders, Deutsche and Commerzbank, who have struggled to recover since the financial crisis.
Government officials, led by Finance Minister Olaf Scholz, have pushed for a merger to create a national banking champion and end questions over the banks' future.
While Deutsche has argued the case that little or no capital may be needed, regulators, worried about the group's U.S. investment bank and the potential fallout of it failing a stress test there in September, are putting their foot down.
The ECB, Deutsche Bank and Commerzbank declined to comment.
With much left to be negotiated in any deal, the size of a capital hole remains unclear but is expected to run into billions of euros.
A merged entity could need up to 10 billion euros (£8.6 billion) of fresh capital because of restructuring costs and the fact that losses on investments could be triggered by a tie-up.
Deutsche Bank's exploratory merger talks with Commerzbank come after prodding by Germany's finance ministry, which is worried about Deutsche's future.
A deal would see Berlin become a shareholder in the combined group. Germany currently holds a 15 percent stake in Commerzbank after a bailout during the financial crisis.
The banks announced on March 17 that they were in talks to merge and a preliminary decision on whether they want to go forward with a merger is expected within days.
Deutsche Bank came under increased pressure on Thursday to move forward on a tie-up with Commerzbank after Italy's UniCredit was named as a potential alternative bidder for the German lender.
UniCredit could explore a merger with Commerzbank if talks with Deutsche fall through, two people with knowledge of the matter said on Thursday.
A potential merger between Deutsche and Commerzbank has met stiff resistance from labour unions fearing jobs cuts, and from some major investors.
Lawmakers are also warning Germany's finance minister they will block any attempt to invest public money in a merged Deutsche and Commerzbank.