By Jesús Aguado

MADRID (Reuters) -Spain's competition watchdog CNMC approved on Wednesday the proposed acquisition of Banco Sabadell by its larger rival BBVA, though the combined lender will have to accept several remedies in its retail banking arm if the long-running hostile takeover bid clears the remaining hurdles.

The deal, valued at around 12 billion euros ($13.59 billion) when it turned hostile last May, is opposed by the Spanish government. An economy ministry spokesperson said it would pore over the CNMC report once it has received it.

The deal also has to be authorised by the stock market supervisor CNMV before the bid can be effectively launched.

BBVA wants to create the second-biggest bank in Spain by credit volume after Caixabank, which would also have over 1 trillion euros ($1.13 trillion) in total assets.

The CNMC said the commitments presented by BBVA to address competition issues in the affected markets were "adequate, sufficient and proportionate."

In a statement, BBVA Chair Carlos Torres Vila said that the remedies that "we assume favor financial inclusion, territorial cohesion, credit for SMEs and the self-employed, and preserve competitiveness, especially in places where Banco Sabadell has a greater presence, such as Catalonia."

Sabadell countered that the methodology used by the CNMC was not "appropriate" to analyse the implications that the combination of both banks would have on SMEs and clients.

The CNMC also concluded that the deal posed a threat to effective competition in certain areas of the retail banking and payment services market, where the merged entity exceeds a 30% combined market share.

BBVA committed to divest certain levels of stakes in payment processing companies (Redsys, Sistema de Tarjetas y Medios de Pago, Bizum and Servired) as mandated by these companies' bylaws.

To address concerns, BBVA said it would not close branches where there is no other branch within 300 metres (0.19 miles), in postal codes with a per capita income below 10,000 euros and where there are fewer than three competitors.

It also vowed not to leave behind any municipality in which there are fewer than three competitors.

As for SMEs and the self-employed, BBVA also committed to maintain working capital lines for three years, extendable by two more years, for all SMEs working with Sabadell.

Under Spanish law, the government cannot stop a bid from being made, but it has the final word on whether a merger goes ahead.

Competition legislation limits the government's scope for intervention but since the antitrust regulator has set remedies in its review, Spain's economy ministry has now 15 business days to take the deal to a cabinet meeting.

The government then has a month to oppose it, known unofficially as a 'phase 3 review'.

($1 = 0.8835 euros)