Sumitomo Trust, another of Japan's largest banks, said on Friday that it was considering a merger with LTCB. It said it wanted to complete the deal as soon as possible although it has not finalised any details of the merger or a deadline for its completion.

The bank's president Atsushi Takahashi, said: "At the beginning of this week LTCB proposed that Sumitomo Trust should merge with them and I have started to think of the merger."

"We think the merger would be done by taking over only healthy loans," Mr Takahashi said, adding "public funds may be needed" to help LTCB offload its bad loans.

He said he was initiating talks about a deal in an effort to compete more effectively with rival international banks.

If the rescue goes ahead it will bring fresh hope that Japan is serious in dealing with the financial crisis that has caused international markets to lose confidence in the yen. The deal has got the backing of the finance ministry and the Bank of Japan.

The shares of both companies were suspended from trading on the Tokyo Stock Exchange on Friday pending the announcement.

Chief Economist at the Profit Research Centre Tokyo Richard Werner talking on BBC Business Breakfast

The LTCB has long been under a cloud because of its bad debts. The bank has admitted to ¥1.4 trillion ($10bn) in problem loans. Its shares have crashed to ¥50 this week, a drop of 98% since their peak. Despite government assurances that the bank would not be allowed to fail, several credit agencies have lowered their ratings in the past week, indicating to investors that it would be risky to buy LTCB stocks or bonds.

On Thursday, LTCB President Katsunobu Onogi said that the bank was considering a merger at its annual shareholders meeting, and he announced a restructuring plan that included layoffs and branch closures.

Bank debts hurt the yen too

The Japanese government has been pushing the banks to clear up the burden of bad debts which has been crippling lending and helping to push the country into recession.

Chief cabinet spokesman Kanezo Muraoka said the country's leading bankers had been trying to ignore the problem too long, accusing them of behaving like "tortoises with their heads pulled in to await the passing storm."

But Sumitomo Trust has indicated that it may require government funds before it agrees to the merger in order to reduce the bad debts. Although financially stronger, Sumitomo has also admitted carrying debts of some ¥1,134bn ($8bn).

Sadaaki Numata, spokesman for the Japanese foreign ministry, said, "We are determined as the most urgent priority to restructure our financial system and promptly dispose of bad assets."

The Japanese government is planning a "bridge bank" to take over help consolidate bad loans and take over lending to companies. The banking sector as a whole is estimated to have over $700bn in non-performing assets.

The news of the possible merger lifted the yen against the dollar, after it fell in Tokyo trading to ¥142.70, a lower level than when the US central bank intervened last week.