The government is adopting an approach that 'encourages but not forces' its domestic banks to merge to create more internationally competitive groups, in a bid to strengthen its financial sector, according to Deputy Prime Minister Lee Hsien Loong. He said potential future mergers between banks in Singapore should be seen as an attempt to create strong Singapore-based entities to compete with international players for domestic and regional businesses. Mr Lee, who also heads the Monetary Authority of Singapore (MAS), said the recent merger between the Development Bank of Singapore and the Post Office Savings Bank of Singapore (POSBank) had been conducted on this basis. The 30-year-old POSBank, wholly owned by the government, has been running its business in a very traditional style - taking deposits from citizens and lending them to government-related statutory bodies to earn only a thin interest spread. People depositing income with POSBank can enjoy tax exemptions on the portion of income deposited at the expense of earning a deposit rate that is lower than the level offered by other commercial banks. Mr Lee said the government had been considering for years the best way of developing the POSBank at a time when the return on the bank's lending to government-related bodies remained low but depositors were becoming increasingly interest-rate sensitive. POSBank had the bitter experience of losing S$1 billon (about HK$4.42 billion) in deposits to commercial banks in less than two months earlier this year when the gap between the bank's savings rate and the commercial rate widened. So merging with a larger player was the best option open for POSBank, Mr Lee said. DBS, despite being Singapore's largest commercial bank, was still aiming to create a bigger 'Singapore flagship' for further international expansion. Mr Lee said the move to encourage more bank mergers had been on the government's agenda long before the outbreak of the Asian crisis because domestic banks were facing increasing pressure from foreign institutions. 'The move [DBS-POSBank merger] is a big step but not the only step that will become necessary,' he said. 'It sets the pace for all banks in Singapore for what the market expects so that they are able to compete given the opening up to foreign participation. 'And it also provides the base for them to operate in the region. Because to go into the region you've got to have a certain mass. You need the capital to be able to take the risks . . . I think it's a significant and not the last step.' Mr Lee said the government considered it in the best interests of the domestic-banking sector as a whole to have fewer but bigger banks.