The potential merger would expand the scope of MIDF’s business and give it the right to take deposits, according to one of the people, who asked not to be identified because the information is private.

A deal could create an entity with combined net assets of about RM1.5 billion to RM2.5 billion depending on the structure of the transaction, the person said.

Deliberations by MIDF and Al Rajhi are at an early stage, and the firms would need approval from Bank Negara Malaysia to formally start detailed negotiations, the people said.

There’s no certainty the discussions will lead to a transaction, according to the people.

If it decides to proceed, Al Rajhi would become at least the second foreign-backed Islamic bank to merge its Malaysian operations with a local financial institution.

Last year, mortgage financing provider Malaysia Building Society Bhd bought Asian Finance Bank Bhd from investors including Qatar Islamic Bank.

MIDF is controlled by state-owned asset manager Permodalan Nasional Bhd.

A representative for MIDF declined to comment, while a spokesman for Al Rajhi didn’t respond to requests for comment. A representative for the Saudi bank’s local arm, Al Rajhi Banking & Investment Corp (Malaysia) Bhd, declined to comment.

Malaysia, which pioneered Islamic finance in the 1980s, aims to have 40% of its banking assets complying with the religion’s ban on interest by 2020. That’s up from an estimated 30% at the end of last year.

As part of its ambition to be a global centre for Shariah-compliant financial services, Malaysia granted licenses in 2004 to Kuwait Investment House, Al Rajhi and a group led by Qatar Islamic Bank allowing them to start Islamic banks in the country.