The battle is now between Malayan Banking Bhd and Bank of China for Indonesia's sixth-biggest lender, while South Korea's Kookmin has also joined the race as a third bidder, a source with direct knowledge of the deal told Reuters.

'It is between Maybank and Bank of China,' the source told Reuters on condition of anonymity because a deal has not been made public.

'HSBC has dropped out.'

Global banks are converging on Indonesia to take advantage of strong growth in Southeast Asia's biggest economy, which is seeing fast-expanding loans and higher earnings potential for its financial sector.

The winner may end up paying over $2 billion if it buys the remainder of BII from shareholders, which include Kookmin, the source added. The decision on Temasek's 42 per cent stake may be announced this week and could be as early as Wednesday.

The source said Temasek was seeking more than $1 billion for the stake, suggesting it was aiming for a premium of 19 per cent or more on the shares, which have a current stock market value of over $840 million.

BII is currently trading at 3.75 times its book value, making it comparable to Chinese lenders that are considered expensive. Bank of China trades at 3.3 times book.

Temasek led a consortium which bought 51 per cent of BII in 2003 for $232 million, or 82 rupiah per share. At the current share price of 415 rupiah, they would stand to gain about five-fold on their original investment.

HSBC declined to comment and it was unclear why it pulled out of the race, but bankers have said the high price was an issue for most potential bidders.

'It is probably valuation and too expensive for HSBC,' said a Singapore-based banking analyst, who asked not to be identified while negotiations were still under way.

Sandy Flockhart, Asia chief executive for HSBC, told reporters earlier this month that the bank was stepping up its presence in Indonesia and other developing Asian economies.

Many lenders predict loan growth in Indonesia of 20 per cent or more this year.

Temasek, which has stakes in two Indonesian banks, is trying to sell its stake in BII to comply with a new rule from Indonesia's central bank that bars foreign investors from owning more than one bank. Temasek also owns a controlling stake in Bank Danamon .

Shares in BII lost early gains on Tuesday to close unchanged, underperforming the broader Jakarta index's 3.4 per cent rally that was led by rises in other banks such as PT Bank Rakyat Indonesia Tbk .

Malaysia's Malayan Banking was up 2.3 per cent.

Maybank in pole position
Maybank, which has been slow to expand outside Malaysia, is considered a top contender because it has looked at the Indonesian market for a long time, analysts said.

'The acquisition of BII would pave the way for Maybank's entry into the higher-yielding Indonesian market and improve the bank's regional footing,' Ivan Tan, Standard & Poor's credit analyst, said in a recent report.

But Maybank or Bank of China will have to pay a high premium for BII, whose shares have rallied 44 per cent so far this year on speculation about the stake sale, beating the benchmark Jakarta index , which is down about 12 per cent.

Goldman Sachs and Credit Suisse are advising Temasek on the deal while Lehman Brothers is advising Bank of China. -- AFP