The Competition and Markets Authority (CMA) said it was considering whether a merger of the two would result in a substantial lessening of competition.

The watchdog also confirmed NSF had offered to demerge its Loans at Home unit, the UK's third-largest provider of home credit, but raised questions over whether the resulting offshoot would be truly independent.

NSF, controlled by funds who also own just over 50 percent of Provident, earlier this month dropped the level of acceptances needed to press ahead with the bid after winning over investors with 53.53% of its shares, well short of its original 90% target.

NSF, led by ex-Provident boss John van Kuffeler, set June 5 as the last date on which the takeover may be declared unconditional. Given that the CMA's initial probe runs for 40 working days, this means NSF could be left in an awkward position if the merger is eventually vetoed by the watchdog.

NSF made its offer following a botched reorganisation of Provident's home credit business that led to profit warnings, its CEO's exit and a dividend suspension.

The CMA, which had already in February indicated potential concerns over the deal by warning against any integration moves while it considers the market impact, noted NSF was proposing Loans at Home would be demerged and then relisted, with shares allocated to shareholders of NSF.

It said that meant shareholders in the enlarged NSF and Loans at Home would be the same and questioned whether the proposal would be effective in preserving competition.

Yet NSF said Loans at Home would be independent and added it expects an agreement in principle to be reached with the CMA.

For a graphic
on NSF powers ahead with hostile bid for bigger, struggling rival, click:

In response, Provident reiterated its concerns about Loans at Home's viability as a standalone business.

Provident flagged that a 40 working day period for the CMA's initial investigation meant the probe would not end before June 5, adding this would leave its investors exposed to a potential unknown and uncosted remedy which it believes would be value destructive.

It also pointed to a risk that the CMA could launch a deeper probe.

"Provident shareholders are not able to assess or even estimate the full economic consequences of the NSF offer and therefore the NSF board should show due consideration to all Provident shareholders by allowing it to lapse," Provident said.

(Reporting by Noor Zainab Hussain in Bengaluru; Editing by Patrick Graham and David Holmes)

By Noor Zainab Hussain