DUBAI (Reuters) - The proposed merger of Saudi British Bank (>> Saudi British Bank SJSC)(SABB) and Alawwal Bank (>> Alawwal Bank) has been delayed but not derailed, financial sector sources said.

SABB, 40 percent owned by HSBC Holdings (>> HSBC Holdings), and Alawwal, 40 percent owned by Royal Bank of Scotland (>> Royal Bank of Scotland Group plc), announced in April that they had agreed to start talks. But progress has since faltered because of the complexity of the deal and for shareholder assessment of any potential impact from the kingdom's anti-corruption drive, the sources said.

The banks have not announced a timetable, but Saudi Arabian central bank governor Ahmed al-Kholifey told Al Arabiya television in October that the outlook for the merger would become clear by the end of 2017.

Consolidation in the sector across the Gulf region has increased in the past two years as profit margins have become squeezed by lower government and consumer spending in the face of weak oil prices.

However, progress on the SABB-Alawwal merger has taken longer than expected because the regulatory environment for bank acquisitions in Saudi Arabia is relatively untested, said two of the sources, who declined to be named because of commercial sensitivities. The last major tie-up was nearly 20 years ago.

Meanwhile, dozens of princes, high officials and senior businessmen were detained in November in a corruption crackdown that has boosted Crown Prince Mohammed bin Salman's power.

Among those was SABB vice chairman Khalid Bin Abdullah al-Mulhem, one of the executives on the bank's merger committee, the sources said. Two sources said Mulhem's detention had not affected the merger talks.

In a roundtable discussion with securities analysts, RBS said it was trying to understand whether the events in Saudi Arabia had implications for the merger.

Almost all banks in Saudi Arabia were affected by the crackdown when authorities ordered the freezing of more than 2,000 accounts across the sector, though industry sources say the number of frozen accounts has since dropped considerably.

A merged Alawwal and SABB would rank as the third-largest bank in Saudi Arabia with assets of $77.6 billion, behind National Commercial Bank (>> National Commercial Bank SJSC) and Al Rajhi Bank (>> Al Rajhi Banking & Investment Corp SJSC), Thomson Reuters data shows.

RBS has been looking to offload its stake in Alawwal for several years. In 2016 it hired Credit Suisse to sell its stake in Saudi Hollandi Bank, which was later renamed Alawwal.

(Editing by Andrew Torchia and David Goodman)

By Tom Arnold