The merger plan between Shinsei Bank and Aozora Bank has hit a gridlock over key issues such as strategy and capitalization of the combined entity, difficulty in integrating systems and on the outcome of an inspection by Japan's Financial Services Agency.

The two Japanese banks entered into merger talks during the height of financial crisis when both fell into the red. That time they agreed to walk away from the deal if either one was not satisfied with other’s capital structure. However, since then, they returned to profitability and have a wide difference in capitalization.

Another hurdle is the future of the combined entity. Both mid-sized banks have been working hard to compete in Japan’s overcrowded banking market. Shinsei specializes in retail banking and forced into the consumer finance space while Aozora’s focuses on deeper relationships with domestic lenders.

Even though both banks intend to work towards the $4.9bn merger, there is every possibility that the talks could extend beyond the October 2010 deadline if the problems are not solved out in time.

Reportedly, Japan’s financial regulator is inspecting the banks’ financial affairs, and based on the results of the inspection, the two banks plan to make a final decision by the end of March 2010.

Rahul Gupta, CFO of Shinsei, said: “We are hoping that the right outcome is reached soon. Clearly there are a number of issues that need to be resolved. It is progressing slowly. It is more important for us to spend time to get it right than just be dictated by a certain date.”