MUMBAI, Oct 30 (Reuters) - India's AU Small Finance Bank is buying IPO-bound peer Fincare Small Finance Bank in an all-stock deal worth 44.11 billion rupees ($529.80 million), as it seeks to expand its presence in southern India and enter the microfinance space.

Shares of AU Small Finance Bank dropped nearly 9% to their lowest since mid-April on Monday on concerns that the deal, announced late on Sunday, would lead to heightened focus on unsecured lending at the bank.

The bank's asset quality deteriorated and provisions for bad loans spiked in the second quarter, according to results released on Saturday.

The main strategic pivot for AU Small Finance Bank in the deal is an increased focus on unsecured lending, said Shailesh Kanani, an analyst at Centrum Broking.

This shift could potentially expose the bank to macroeconomic challenges, which it has so far managed to weather more effectively than its peers, he added.

Over half of Fincare's asset portfolio is made up of microfinance, or loans to low-income individuals or groups who typically find it tough to borrow funds from banks.

Meanwhile, AU Small Finance's biggest share of loans is in vehicle purchase financing.

The announcement of the deal comes weeks after Tiger Global-backed fintech Slice said it would merge with North East Small Finance Bank, a small-sized lender with operations focused on India's north-eastern region.

Shareholders of Fincare Small Finance Bank, which had filed IPO papers in May, will receive 579 equity shares of AU Small Finance Bank for every 2,000 shares of the former. Fincare has about 221 million outstanding shares, its IPO filing showed.

The combined entity will have a balance sheet of 1.1 trillion rupees. Fincare shareholders will hold close to 9.9% in AU Small Finance Bank after the deal.

Fincare employees will join AU Small Finance Bank while Fincare's chief executive Rajeev Yadav will be designated as deputy CEO of AU Small Finance Bank.

The transaction will need to be approved by the Reserve Bank of India and is subject to a capital infusion of 7 billion rupees by Fincare shareholders.

The appointed date for the amalgamation is proposed for Feb. 1, 2024.

($1 = 83.2580 Indian rupees) (Reporting by Ira Dugal and Chris Thomas; Editing by Rashmi Aich and Mrigank Dhaniwala)