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The deal is likely to attract regulatory scrutiny, with the Office of Fair Trading taking into account any combined group's share of audience and ad revenue on a region-by-region and national basis.

Earlier this week, Capital and GWR, the owner of the national station Classic FM, confirmed speculation that they were holding merger talks.

There is an obvious synergy because Capital does not own a major national analogue station - so Classic would plug this gap - while GWR is relatively weak in London, Capital's heartland.

A deal, which would create a group worth almost £1 billion, could lead to further consolidation in the radio market. The other major commercial operators (Emap, Chrysalis, Guardian Media Group, The Wireless Group, Scottish Media Group and Scottish Radio Holdings) are likely to consider deals.

Emap, the next largest radio group, already owns a 27.8 per cent stake in SRH and a full acquisition of the company is a distinct possibility.

Reports have also suggested a merger between Emap and Chrysalis could be on the cards.

Between them, Capital and GWR own 55 stations, the largest being Classic FM and Capital's 95.8 FM in London, BRMB in Birmingham and the Century networks.

David Mansfield, the chief executive of Capital, is expected to take the same role at the merged group, with Ralph Bernard, the executive chairman at GWR, taking on the role of chairman.

A statement from the companies issued on Monday said: "The boards of Capital and GWR note recent press speculation and confirm they are currently in discussions concerning the possibility of a nil-premium, all-share merger. These discussions are ongoing and may or may not lead to a transaction."

Their ad sales operations are likely to be consolidated as part of the merger, with analysts predicting that this, along with the merger of administrative departments, will result in £8 million of savings. Such savings could be achieved because Capital and GWR together employ more sales people than Carlton and Granada before their merger.

Potential areas of concern for the regulators, with the OFT deciding whether to refer any deal to the Competition Commission, include Capital's strength in the London market, combined with the Classic FM audience and potential overlaps in the Midlands, where Capital's station Century 105.4 FM currently competes against GWR's two stations.

Last year, GWR was blocked in its attempt to acquire a 49 per cent stake in Vibe Radio because of potential dominance in particular local radio markets.

Daily Mail & General Trust, which owns 29.9 per cent of GWR, could also play a part in approving or blocking the merger. The merger plans will be presented to Daily Mail & General Trust by Capital and GWR management in an attempt to win its backing.

ISBA said any deal would raise important issues for advertisers: "ISBA notes that, combined, GWR and Capital would control some 40 per cent of the national radio advertising market. This is a significant market share in radio - a very strategic medium for advertisers."

ISBA said it would be keen to be involved in an OFT/Competition Commission inquiry if the merger talks prove to be successful.

However, analysts said they expected a merger would be investigated and subsequently approved by the regulators. Lorna Tilbian, an analyst at Numis, said: "There is no material overlap between the local/regional stations owned by Capital and those of GWR. We believe the national radio advertising revenues of GWR and Capital are £64 million and £83 million respectively, giving group national radio revenues of £147 million."

Tilbian pointed out that this 40 per cent share is lower than that of the merged ITV in the television market and that radio accounts for just 7 per cent of total national display advertising revenue, against TV's revenue share of more than 30 per cent.

The Communications Act cleared the way for consolidation of the radio industry and for companies from non-EU countries to acquire UK radio interests.

US radio companies, such as Clear Channel, were widely expected to acquire large radio companies but there has been no activity so far. Clear Channel has said it believes the value of radio companies is over-inflated.

Both Capital and GWR experienced falls in audience at key stations in the last set of Rajar audience figures. 95.8 Capital FM's share of London listening dropped from 7.9 per cent to 6.6 per cent during the second quarter following the arrival of Johnny Vaughan as its breakfast presenter, while Classic FM experienced a slight drop in its audience.

CAPITAL'S AND GWR'S MAJOR ASSETS

STATION REGION Weekly audience

(000s)

CAPITAL

95.8 Capital FM London 2,100

Capital Gold London 778

105.4 Century FM Manchester/Liverpool 754

Xfm 104.9 London 577

96.4 FM BRMB Birmingham 567

GWR

Classic FM National 6,500

GWR FM West Country 414

Essex FM Essex 329

96 Trent FM Nottingham 323

Beacon FM West Midlands 303