By Bernardo Vizcaino

April 22 (Reuters) - Pakistan's MCB Bank Ltd MCB.KA will set up a wholly owned Islamic banking subsidiary while dropping plans to take a stake in Islamic lender Burj Bank, according to a filing with the Karachi stock exchange.

Last month, MCB started due diligence on taking a 55 percent stake in unlisted Burj, which held assets worth 53.3 billion rupees ($547 million) as of December, but it said it would not proceed for commercial reasons.

Those plans would have included an additional investment by the private-sector arm of Jeddah-based Islamic Development Bank

ISDBA.UL , which already holds a 33.9 percent stake in Burj.

ID:nL5N0LI00R

Bahrain's Bank Alkhair is its largest shareholder, with a 37.9 percent stake in Burj, which it has classified as held-for-sale since June 2012.

The move comes amid increased activity in Pakistan's Islamic banking sector, with regulators stepping up development efforts and lenders expanding operations in the world's second-most populous Muslim nation.

Burj Bank is the smallest of five full-fledged Islamic banks in Pakistan with a network of 75 branches, while MCB operates the country's sixth-largest Islamic window with 28 branches, which it established in 2003.

MCB had earlier said it would spin off its Islamic window into a separate subsidiary with 10 billion rupees in paid-up capital, using its existing Islamic banking branches to form the new entity.

As of December, Islamic banks held a 9.6 percent share of total banking assets in Pakistan, compared with around 25 percent in the Gulf Arab region. ($1 = 97.5250 Pakistani rupees)

(Editing by Chris Gallagher)

((Bernardo.Vizcaino@thomsonreuters.com)(Telf: +9715 6655 7225)(Reuters Messaging: bernardo.vizcaino.thomsonreuters.com@reuters.net))

Keywords: ISLAMIC FINANCE/PAKISTAN