LONDON (Reuters) - Britain's Nationwide Building Society has agreed to buy Virgin Money UK ( CYBBF ) in a potential 2.9 billion pound ($3.7 billion) all-cash deal to create the country's second-largest savings and mortgage provider.

The proposed deal is the latest example of a bounce in merger and acquisition activity among British lenders, with some seeking to bolster their balance sheets against a possible bump in bad loans as households and businesses face a recession.

Barclays ( JJCTF ) said last month it would buy the banking operations of supermarket group Tesco ( TSCDF ) for about 600 million pounds and some analysts said the Nationwide's move could prompt deals by others looking to preserve market share.

Nationwide said its offer of 220 pence per Virgin Money share represented a premium of 38% as of March 6 and would be funded through the mutual's existing cash resources.

Virgin Money's shares were up 36% to 217 pence at 1242 GMT, and were set for their biggest one day gain since its initial public offering (IPO).

Richard Branson's Virgin Group Holdings, which founded Virgin Money and which holds around 14.5% of its total shares in issue, has also indicated support for the deal.

Analysts said the transaction could increase competition in Britain's mortgage and savings market and spur a revival in some bank stocks, which have wilted in the face of geopolitical tensions and lacklustre economic growth.

"With the outlook for the UK economy stabilising, we wouldn't be surprised to see more deals like this," RBC Capital Markets analyst Benjamin Toms told Reuters.

"UK bank valuations are relatively cheap for the sustainable returns they offer," Toms added.

MUTUALLY-OWNED

Nationwide, which describes itself as the world's largest building society, itself a product of several takeovers and mergers, would remain a mutually owned lender under the terms of the offer, which remains subject to conditions.

It holds almost 1-in-10 pounds saved in Britain, as well as one in ten of the UK's current accounts. It has more than 17 million customers and employs more than 16,000 people.

Virgin Money is the UK's sixth-largest retail bank by assets and has around 6.6 million customers, with total lending of 72.8 billion pounds including around 57.1 billion in mortgages.

Its board said it had carefully evaluated the Nationwide deal and was likely to recommend it to shareholders.

Nationwide said the deal would allow it to offer a wider range of products and services and build its financial strength.

It currently operates Britain's largest single-brand high street branch network, spanning more than 60 outlets, and said it intends to retain a branch everywhere where the combined group is present, until at least the start of 2026.

Most other major UK banks have slashed branches in a bid to save costs, citing the rising popularity of online banking.

"A combined group would bring the benefits of fairer banking and mutual ownership to more people in the UK, including our continuing commitment to retain existing branches," Nationwide CEO Debbie Crosbie said.

If the deal goes ahead as announced, the new entity would have assets of approximately 366.3 billion pounds, with lending and advances of around 283.5 billion.

Nationwide said it did not intend to make any material near term changes to the size of Virgin Money's 7,300-strong workforce in the near term.

"A mutual taking over a listed bank is a rare move but Nationwide clearly doesn't want to be stuck in the past and wants the know-how and access to scoop up future customers who demand more cutting edge financial services," said Susannah Streeter, head of money and markets at Hargreaves Lansdown.

Virgin Money CEO David Duffy said the deal would "complete our journey in the banking sector as a national competitor".

Nationwide said it would seek to integrate Virgin Money gradually over several years, but in the medium term the bank would continue to operate as a separate legal entity with a separate board of directors and banking licence.

Virgin Money's 9 billion pounds in business lending would enable Nationwide to build on its existing business savings business and diversify its funding sources, Nationwide said.

($1 = 0.7851 pounds)