Spanish lenders Bankia and Caixabank are considering a merger to create the country's biggest domestic bank.
A deal would give them $770 billion in total assets.
Announcing the talks late on Thursday (Sep 3) Caixabank said it was discussing an all-share merger.
And Bankia confirmed negotiations were under way.
The number of lenders in Spain has shrunk by three-quarters since the 2008 financial crisis.
The latest slowdown is putting further pressure on banks to merge as they set aside costly provisions.
Low interest rates in the euro zone have also weighed and regulators have been pushing for consolidation to reduce costs.
Although Santander and BBVA are bigger banks because of their extensive overseas businesses, a tie-up between Caixabank and Bankia would create Spain's biggest player at home.
The Spanish state holds a stake of over 60 percent in Bankia.
It was bailed out in 2012 through a 22.4 billion euro rescue package, to recover from property loan losses at the height of Spain's financial crisis.
The government has been looking for ways to recover some of its money.
And has until the end of 2021 to offload its stake.
So far this year, shares in Bankia have fallen more than 45%.
While shares in Caixabank have fallen more than 35%.
On Friday European banking stocks were lifted by the news.
Sources say the two could close a deal within days.