http://online.wsj.com/public/article/SB115660412572946508-WVer1qCztuNN1y6KZHwX5JYz9CA_20060903.html?mod=regionallinks

By merging Italy's Banca Intesa SpA and Sanpaolo IMI SpA, the architects of the deal aim to create a player with enough heft to be a driver in European banking consolidation.

Saturday, the boards of the banks agreed to the terms of a merger, valued at about £¿9.43 billion ($37.54 billion). The deal would catapult the two midsize national players into a bank with a market capitalization of around £¿0 billion that would likely rank No. 4 in the euro zone. However, in cases of domestic megamergers like this one, success hinges on whether Intesa, of Milan, and Sanpaolo, of Turin, can achieve the promised savings and synergies, and in particular whether they can deliver on job reductions, which could be as high as 10% of total staff.

Under terms of the deal, which is to be put to shareholders for approval at extraordinary meetings in December, Intesa is offering 3.115 of its shares for every Sanpaolo share.

The transaction comes at a time when cross-border banking deals throughout Europe have been on a sharp rise and shortly after foreign players such as ABN Amro Holding NV of the Netherlands and France's BNP Paribas SA took control of a pair of midsize Italian banks, adding to competitive pressure in one of Europe's most lucrative banking markets.

Foreign entrants are upping the ante in one of Europe's most fragmented and, until recently, sheltered banking markets. Pressure to become more competitive has risen since Mario Draghi took over as Bank of Italy governor from Antonio Fazio. Mr. Draghi is seen as someone who takes a more open-market view to cross-border deals than his predecessor, who had hindered foreign takeovers of Italian banks.

The architects of the Intesa-Sanpaolo merger, which would be the largest domestic banking merger in Europe in a decade, said they see the deal as a first step in creating a bank that is much better positioned to compete in further consolidation across the Continent. That wasn't possible when the two operated separately. They both lacked sufficient size and were hampered by shareholders who didn't want to see their influence diluted through an expensive acquisition.

The combined entity stands to control roughly 20% of Italy's retail-banking market. That would give it a strong position in the domestic market and enough free cash flow to focus attention abroad.

A person involved in the negotiations said the new bank could begin to look for acquisitions as early as a year from now. Advisers and executives who worked on the deal stressed that any foreign acquisition would only follow a successful integration of the two banks.

On its own terms, that integration could prove very lucrative. Domestic in-market acquisitions generate almost double the economic value added that cross-border transactions do, according to a study on European banking consolidation by Keefe, Bruyette & Woods. Joining two local players can help save 21% of the target's cost base.

However, the success of any domestic merger depends on the banks' being able to eke out those savings.

The executives of the two banks said they plan to find about £¿.3 billion in cost savings by 2009, achieved by measures such as integrating information technology. They predicted that combining operations would result in annual net-profit growth of 13% and would achieve net profit of about £¿ billion by 2009. The merger would result in a pretax charge of £¿.5 billion, the banks said.

The savings targets are in line with those for other European domestic merger deals, said Marcello Zanardo, an analyst in London with Keefe Bruyette. Achieving those savings often requires significant work-force reductions, something difficult to carry out under Italy's strict labor laws.

Executives gave no details about potential layoffs following Saturday's meetings. An adviser who worked on the deal said there were no plans for layoffs in the banks' retail networks.

Mr. Zanardo said cost-savings targets imply that around 10,000 employees -- about 10% of the overall work force -- will leave. Forced layoffs are extremely difficult in Italy because of restrictive labor laws, but staff reductions are possible through the sale of bank branches to competitors and because of the agreed sale by law of the tax-collection activities, which employ more than 3,000.

Still, the lack of clarity about how these reductions could be achieved sparked some skepticism among industry analysts. "Achieving cost savings is ultimately a matter of layoffs, and flexibility on this is limited in Italy," Citigroup wrote in a research note last week.

Yesterday, unions representing bank workers demanded a meeting with the management of the two banks and declared that they were opposed to any plan that included forced layoffs.

Under the merger terms, the new, and as yet unnamed, bank will have Banca Intesa Chief Executive Officer Corrado Passera as its chief executive. Intesa Chairman Giovanni Bazoli will head a supervisory board, while Sanpaolo Chairman Enrico Salza will head a management board.

Shares in Sanpaolo closed Friday almost 3% higher at £¿6.05, while Intesa shares closed 0.5% higher at £¿.05. Cr¨¦dit Agricole SA, of France, which wields veto power over the deal as the largest player in Intesa's shareholder pact, has cautiously backed the terms of the plan. In a statement Saturday, the French bank said final approval was "subject to reaching an agreement which safeguards and enhances the value of Cr¨¦dit Agricole's strategic interests in the Italian market."

A person close to Cr¨¦dit Agricole said the French lender remains prepared to exercise its veto power as negotiations continue. Mr. Bazoli called Cr¨¦dit Agricole's conditions "reasonable," adding that the deal would include "solutions to best protect their strategic interests."