DEFYING earlier market rumours and analysts' expectations, the two Indonesian banks controlled by Temasek Holdings may be headed for a merger.

Bank Internasional Indonesia (BII), the country's sixth-largest bank by assets, says that it is drafting a proposal to merge with Bank Danamon.

Admitting the move in an interview with Bloomberg this week, BII president-director Henry Ho said: 'Prima facie, it does seem to make sense but it needs to be validated.' He said that the two banks complement each other.

The proposed merger flies in the face of recent market talk and media reports that Temasek plans to divest the underperforming BII. South Korea's largest lender Kookmin Bank has been named as a possible buyer. Mr Ho's remarks confirm what a BT source indicated back in June. Casting doubt on divestment rumours, the industry insider told BT then that Temasek had turned down several offers from foreign banks to buy its BII stake.

The Singapore investment company owns a 35 per cent stake in BII through a consortium it leads, named Sorak Financial Holdings, which owns 56.9 per cent of BII overall. Temasek also holds a 59 per cent stake in No 5 lender Bank Danamon.

But under an impending single-presence policy, investors can no longer own controlling shares in more than one bank. Those with multiple controlling stakes now have three options.

The first is to keep one and either divest the rest entirely or dilute shareholding in them to below 25 per cent. The second is to merge them all. And the third is to inject them into a single financial holding company.

Bank owners have until the end of the year to submit their plans to the central bank, which is trying to trim Indonesia's brood of about 130 banks down to 80. The consolidation process is expected to be completed by 2010.

BII's Mr Ho ruled out forming a holding company - an option analysts say is not viable owing to prohibitive tax costs.

His counterpart at Danamon, Sebastian Paredes, however, is keeping his cards much closer to his chest. 'It's very premature now to say which way it's going to happen,' he told BT last night.

Mr Paredes said that the bank is still studying all the options and analysing which would best serve it. 'Bank Danamon has to make a position which is the best position for Bank Danamon and all our shareholders,' he said.

Asked if he had discussed the matter with BII's Mr Ho, Mr Paredes would only say: 'We are studying internally within Bank Danamon. We are very busy doing that.'

Analysts say a merger as suggested by BII may not be wise. First, it may not add value to the banks because their businesses overlap. 'Both companies have the same business type, which may not bring synergy if a merger happens,' said PT UOB Kay Hian Securities' Yap Swie Cu.

Second, BII's lacklustre performance, compared to Danamon's better showing, could drag down the overall value of the merged entity. BNI Securities' Fendi Susianto noted that Danamon boasts a return on equity (ROE) of 21 per cent and a net profit margin of up to 13 per cent, versus BII's 8.5 per cent ROE and 6-7 per cent net profit margin.

Both Mr Yap and Mr Susianto recommend that Temasek sell its BII stake.

For its part, Temasek told Bloomberg it is leaving the decision to the two local banks. Spokeswoman Myrna Thomas said in an e-mail statement: 'Bank Internasional and Bank Danamon have their own boards and management. They will each have to determine what makes sense for their business.'