By Tom Fairless 

BRUSSELS--European Union regulators said Monday they had approved Banco de Sabadell SA's GBP1.7 billion ($2.66 billion) takeover of TSB Banking Group PLC, in a move that allows Lloyds Banking Group PLC to fulfill a key condition of its EU-sanctioned restructuring plan.

The European Commission, the bloc's top antitrust authority, said the deal raised no concerns because of the companies' "moderate combined market shares and limited overlap on the markets concerned."

Lloyds, which floated a minority stake in TSB at 260p a share last June, said in March would sell a 9.99% stake in TSB to Sabadell and has agreed to accept the offer for its remaining 40% shareholding.

The U.K. bank spun out TSB as a separate brand after the EU demanded that it unload more than 600 branches as a condition of its GBP17 billion bailout by U.K. taxpayers in 2008. It has been touted by the British government as a "challenger" bank aimed at breaking the hold of the U.K.'s four largest retail lenders.

In statement, the commission said the "backing of a larger banking group like Sabadell will enhance TSB's ability to compete as a challenger bank and stimulate competition in the British retail banking markets, to the benefit of U.K. consumers."

Sabadell, Spain's fifth-largest lender, has been an active consolidator during the Spanish banking crisis, buying several struggling lenders at deep discounts. But it has made few moves outside its home market. Sabadell has said the acquisition of TSB will increase its assets outside Spain from 5% to 22% of its total.

"Lloyds' recent progress, including the sale of its stake in TSB approved today, shows the effectiveness of EU state aid rules," the EU's antitrust chief Margrethe Vestager said in a statement.

David Wighton

in London contributed to this article.

Write to Tom Fairless at tom.fairless@wsj.com

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