Dubai said it will inject an unspecified amount of capital into the bank and its takeover would protect depositors’ interests.

“In terms of credibility of the UAE banking system, it was very important that the bank did not default. A default by Dubai Bank would have raised worries about other local banks operating in the country,” Mohammed Yasin, chief investment officer at CAPM Investments in Abu Dhabi, said.

Options for Dubai Bank included being run on a stand-alone basis or merged with another state-owned bank, the government said in a statement.

Dubai already has stakes in six commercial banks in the UAE, including Emirates NBD, Dubai’s largest by market capitalization, Dubai Islamic Bank and Noor Islamic Bank. Dubai Bank has been under scrutiny for a while.

“There have been questions raised about the sustainability and continuity of their operations for a while. The bank has some serious liabilities outstanding and those need to be addressed,” CAPM Investment’s Yasin said.

Fitch downgraded it in March, citing its weakened financial flexibility and exposure to Dubai entities that are being restructured. The ratings agency declined comment on Monday.

Dubai Bank has exposure to a syndicated $2.25 billion Islamic tranche to Investment Corporation of Dubai which lenders agreed to refinance just two weeks ago.

At the end of 2009, Dubai Bank had total assets of AED17.4 billion ($4.74 billion) against total liabilities of 15.7 billion dirhams. It made a loss of AED290.6 million.

It has not yet reported its 2010 results. Customers deposits stood at AED14.9 billion at the end of 2009.

By contrast, Emirates NBD — formed by a 2007 merger of two local banks ordered by Dubai’s ruler — had total assets of AED300.3 billion versus total liabilities of AED266.3 billion as of March 31, according to Reuters data.

Dubai has been restructuring state-linked firms to deal with a debt pile estimated at $115 billion built up during a boom that put the emirate on the map for extravagant construction projects such as an indoor ski slope in the desert.

The extent of its problems became clear when flagship conglomerate Dubai World asked for a standstill on $26 billion of debt in 2009. It eventually reached a restructuring deal with creditors late last year.

Neighboring Abu Dhabi has been central in keeping Dubai afloat. The UAE central bank and Abu Dhabi extended Dubai a $20 billion lifeline in 2009. Dubai said the central bank and UAE finance ministry support the takeover.

Dubai Bank is wholly-owned by Dubai Banking Group which itself is 70 percent-owned by Dubai Holding. The remaining 30 percent is owned by developer Emaar Properties.

“It’s positive because it reduces any uncertainty around the future commitments that Emaar or Dubai Holding would have to make to Dubai Bank,” said Abdul Kadir Hussain, Chief Executive of Mashreq Capital.

“But the total economics are unclear. We don’t know the size of the injection or how it will be financed.”

Shares of Emaar, whose stake is worth 172.4 million dirhams, fell 2.2 percent. Dubai’s index shed 1.5 percent at 0918 GMT. Enaar said it was “awaiting further directives and details from the Dubai Government in respect of the takeover.”

The government said the bank’s current management team will not be affected by the takeover. Dubai Bank reorganized its operations last year, positioning itself as a retail bank for premium customers with merchant banking on the corporate side.

There was speculation last year that Emirates Islamic Bank, an affiliate of Emirates NBD, was in talks to buy it.

And last month, Noor Islamic Bank’s chief executive said it had no plans to merge with any other financial institution for the time being.