Saudi Arabia plans to establish a sovereign wealth fund that is expected to dwarf Abu Dhabi's $900bn (£454bn) and become the largest in the world.

The new fund will be a formidable rival for other government-owned investment funds in the Middle East and Asia, which are playing an increasingly active role in channelling capital to western companies, particularly financial companies hard hit by the US mortgage meltdown.

News of the Saudi plan comes as Temasek of Singapore is in "preliminary" talks with Merrill Lynch concerning a multibillion- dollar stake in the ailing investment bank, according to a person familiar with the matter.

"Merrill and Temasek have been talking for a while about this, although there are no indications that a deal is imminent," the person said. Temasek was also approached as a possible investor in UBS and Morgan Stanley, although the investment banks later struck deals with Government of Singapore Investment Corp and China Investment Corp respectively, the person said.

These stakes have avoided a serious political backlash but potential investments from the Saudis are likely to be subject to greater scrutiny.

The effort is likely to be spearheaded by Saudi Arabia's Public Investment Fund, which has a mandate to invest only internally.

Previously, the Saudis' oil wealth had gone partly to the kingdom's central bank, the Saudi Arabian Monetary Authority, and partly into the coffers of the ruling family.

While the balance sheet of SAMA is public information, bankers say the figures capture only a percentage of the total wealth of the country. The myriad investment vehicles of the royal family have never been transparent.

Until now, SAMA's investment policy has been conservative and largely limited to investment in bonds, especially US Treasuries, and shares.

That contrasts with the mandate of its peers in the Gulf, which have increasingly been geared to provide higher returns for when oil reserves run out, by investing in alternative assets such as private equity and hedge funds.

In contrast to its neighbours, Saudi Arabia has expanded its spending and next year's budget includes funds for infrastructure projects.

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