UPDATE 2-Australia's Westpac scraps potential demerger of NZ business

* Bank to keep NZ unit, priority is to appoint CEO

* Costs and complexity likely reason - analysts

* Decision indicative of judgment call faced by peers - Citi (Recasts, adds details and analyst reaction)

SYDNEY, June 24 (Reuters) - Australia’s second-largest lender Westpac Banking Corp said on Thursday it would retain its New Zealand business, wrapping up the option of a spin-off, after a review likely found that a demerger would have been too costly.

Without providing further details, Westpac said in a statement that a review to consider a spin-off, triggered by New Zealand’s tighter capital norms, had found that a demerger would not be in the best interests of shareholders.

A decision to demerge the business could have encouraged some of its Australia-based peers who alongside Westpac dominate 85% of the New Zealand market - Australia and New Zealand Banking Group, Commonwealth Bank, and National Australia Bank - to follow its lead.

The decision “likely reflects the complexities of divesting from a liquidity and capital perspective,” Citigroup banking analyst Brendan Sproules said in a note.

“We view this decision as being indicative of the judgment call faced by peers, and consequently think the issue of divesting NZ subsidiaries has now been put to bed.”

The Australian bank said its priority is to appoint a new chief executive to replace the unit’s boss David McLean, who is set to retire on June 25.

Seeking to safeguard the New Zealand banking system, the country’s central bank has been separating operations and capital of local units from its Australian parents.

The high costs involved have challenged the outlooks of the Australia-headquartered “Big Four” lenders, with analysts estimating their return on equity ratios could fall by between half and a third from the about 15% they used to deliver.

Westpac said it would instead work on “opportunities” the review had identified to improve value across the business, without elaborating.

While New Zealand investors were very supportive of the potential listing, JPMorgan banking analysts told clients in a note that the unit, on its own, “would borrow at a higher cost and operating expenses would also be modestly higher.”

“With NZ retained within the group, we think it needs investment given it has been losing market share in recent years and has an NPS score, which is well below the other major banks.”

Westpac’s New Zealand unit represents about 10% of its earnings and credit exposure. According to audit firm KPMG, it was expected to be valued at over A$10 billion ($7.60 billion). (Reporting by Paulina Duran and Rashmi Ashok, Additional reporting by Tejaswi Marthi in Bengaluru; Editing by Arun Koyyur and Sherry Jacob-Phillips)