By Engen Tham, Summer Zhen and Selena Li

HONG KONG/SHANGHAI (Reuters) -Credit Suisse has scrapped plans to set up a locally incorporated bank in China to sidestep a potential regulatory conflict arising from its merger with UBS, said two sources with direct knowledge of the matter.

Embattled Credit Suisse had been preparing for years to set up a wholly owned local bank in China. A locally incorporated bank would have boosted its presence in the country by allowing it to set up a branch network to draw deposits and expand its onshore wealth management business.

The reason for the Swiss lender's decision was that UBS, which is acquiring Credit Suisse as part of a government-orchestrated rescue of its smaller rival, already has a locally incorporated bank in China, said the sources.

In China, a financial entity can apply for and get only one such license.

Credit Suisse's decision to ditch its local bank plan could be a precursor to similar moves it and UBS make on other businesses in China such as asset management and brokerages where they both have operating units, in order to not breach regulations.

Credit Suisse and UBS declined to comment. China's banking regulator, the National Financial Regulatory Administration, did not immediately respond to a Reuters request for comment. The sources did not wish to be identified due to the sensitive nature of the matter.

It was not immediately clear if the local regulators have been informed of Credit Suisse's decision, but one of the sources said that the move to drop the plan had been communicated to the bank's local staff.

TRICKY MARKET

UBS, twice as big as Credit Suisse by assets, agreed to buy its cross town rival for 3 billion Swiss francs ($3.3 billion) in stock and to assume up to 5 billion francs in losses in March.

The clock is ticking for UBS to close the deal with Credit Suisse. UBS Chief Executive Sergio Ermotti said earlier this month that the Swiss bank was working on closing its merger by the end of May or early June.

China could be among the most tricky markets for the two banks to consolidate their local operations, with overlapping businesses covering investment banking, wealth, and fund management.

The future of the two firms' China securities joint ventures is also uncertain, with Credit Suisse's 51%-owned securities venture likely being put on the block to avoid breaching China's license ownership rules, the two people and a third source said.

Credit Suisse is trying to retain bankers at the joint venture, as it struggles to maintain the number of staff in order to remain compliant before it decides whether it should be sold, the third source said.

The China Securities Regulatory Commission did not immediately respond to a Reuters request for comment.

The Credit Suisse joint venture, which housed 234 staff as of end of last year, booked a net loss of 254 million yuan ($35.87 million) in 2022, mainly due to a slump in commission and investment banking income, according to its annual report.

Under Chinese regulations, a foreign firm can only have one majority-owned securities firm in the country. UBS currently runs a 67%-owned securities joint venture with a Beijing state-owned company.

(Reporting by Summer Zhen and Selena Li in Hong Kong and Engen Tham in Shanghai; Editing by Sumeet Chatterjee and Muralikumar Anantharaman)