Three of Japan's largest banks said today that they are discussing a possible alliance that could result in the creation of the world's largest private bank.

The merger would unite the Industrial Bank of Japan Ltd., Japan's last bank to specialize in long-term loans to Japanese companies, with Dai-Ichi Kangyo Bank Ltd. and Fuji Bank Ltd., two of Japan's largest commercial banks.

A single entity forged from the three behemoth lenders would have combined assets of about $1.26 trillion, eclipsing Deutsche Bank AG, currently the world's biggest bank.

The three banks said they have explored the possibility of an alliance but have not concluded a final agreement. Executives at the three lenders declined to confirm details of the terms of the proposed partnership, which were outlined this afternoon in the Nihon Keizai Shimbun, Japan's leading business daily.

Bank officials said they would offer more information about their discussions at a news conference in Tokyo Friday afternoon.

The newspaper said the three banks had reached broad agreement on a plan to create a holding company that would pave the way for a more formal integration of their operations. The holding company would be established as early as fall of next year, according the report. The three banks' operations would then be consolidated into retail, commercial and investment banking divisions.

Analysts in Tokyo hailed the prospective merger as a constructive step in restructuring Japan's troubled banking sector, which could spur the nation's economic recovery.

The bursting of Japan's stock and property bubble in the early 1990s left big banks buried under a mountain of nonperforming loans--loans that are not earning interest. Banks' inability to shed unprofitable assets, cut costs and resume regular lending activity is widely regarded as a primary reason for Japan's failure to shake off its worst recession since World War II.

Word of a possible merger sent share prices of all three banks soaring in afternoon trading today. Japan's benchmark Nikkei 225-stock index, which began the day down more than 200 points, recovered immediately on the news. The Nikkei closed at 17,879.74, down 12.52 points from Wednesday. Minutes before the closing bell, the Tokyo Stock Exchange suspended trading in shares of the three banks.

Analysts said the Industrial Bank of Japan would benefit most from the proposed alliance. It boasts the most distinguished client roster in Japan and recruits its executives from the upper echelons of Japan's most prestigious universities.

Over the years, the Industrial Bank of Japan has arguably done more than any other nongovernment institution to fuel the remarkable growth of Japan's industrial juggernaut. Still, it has been hobbled in recent years by regulations that prevent it from accepting deposits from individuals. That weakness played a key role in the demise last year of Japan's other long-term credit banks, which were created decades ago to finance industrial growth and were allowed to raise money by selling debentures to the government.

Fuji and Dai-Ichi Kangyo have large bases of individual investors' deposits, but they lack powerful international or wholesale securities operations; the Industrial Bank has long excelled in those areas.

It was not clear today whether the proposed alliance has the blessing of the powerful Ministry of Finance. But financial analysts in Tokyo said it was unlikely that the three banks would even be talking without the ministry's approval.

Many analysts speculated that the government would come forward with public funding or regulatory breaks to facilitate the alliance. Some speculated that the alliance could offer a blueprint for consolidation of other lenders.

"The good news here is that this demonstrates the credibility of financial authorities who have been promising there would be tremendous consolidation in the banking sector," said James Fiorillo, an analyst with ING Barings in Tokyo. "The long-term implications are very positive."

Although the three banks are all Japanese institutions, integrating their divergent cultures will not be easy. In a nation that shuns American-style downsizing, bank mergers tend to proceed at a glacial pace. For example, Dai-Ichi Kangyo, itself an amalgamation of two other major banks, has only recently managed to unify its operations. For years it maintained separate personnel departments for employees of its two original banks and eschewed closing overlapping branches.

Akiko Kashiwagi in Tokyo contributed to this report.