This article first appeared in The Edge Malaysia Weekly, on January 25 - 31, 2016.

TALKS between Malaysia Building Society Bhd (MBSB) and Bank Muamalat Malaysia Bhd to create the country’s largest stand-alone Islamic bank seem to have hit a snag and the merger may even be called off.

There’s just a week left for them to strike a deal, but sources say there has been little progress so far, citing valuation and control issues.

“They’re not calling it a day yet. But with just a few days left and neither side looking ready to budge, it’s likely that the merger plan will be aborted,” a source tells The Edge.

Bank Negara Malaysia last week approved their requests for a one-month extension to Feb 2 to conclude negotiations after they failed to do so within the stipulated three-month period to December 2015.

It is understood that Feb 2 is the final extension the central bank is giving them. This gives them roughly a week to come to an agreement and make their submissions to Bank Negara, considering the Federal Territory Day public holiday on Feb 1.

Based on talks so far, the plan is to have the merger effected via a share swap. One source says the parties involved have not been able to agree on valuations as Bank Muamalat’s 70% shareholder DRB-Hicom Bhd is expecting an “unreasonably high” valuation for its Islamic banking asset.

It was initially expected that the shareholding structure of the merged entity would be such that the Employees Provident Fund (EPF) ends up as the largest shareholder with a 40% stake, followed by DRB-Hicom with slightly less than 30% and Khazanah Nasional Bhd, which owns the remaining 30% stake in Bank Muamalat, about 10%.

But DRB-Hicom has indicated that it wants a larger shareholding and at least equal control with the EPF, if not more, the source says.

The Edge reported two weeks ago that the EPF, which is MBSB’s largest shareholder with a 65% stake, and DRB-Hicom were each jostling to be the controlling shareholder in the merged entity.

Banking sources have said it makes more sense that the EPF/MBSB party be in control of the merged entity given that MBSB is twice the size of Bank Muamalat in terms of assets. Moreover, over 80% of their combined revenue and profit before tax would come from MBSB.

It remains to be seen if the parties will make a last-minute effort to ensure that the merger plan becomes a reality.

But should they decide to call off the merger, both MBSB and Bank Muamalat will have to go back to the drawing board with regard to their future.

For non-bank lender MBSB, which has been pursuing the merger and acquisition path to enable it to get onto a banking platform, it could be its second failed merger attempt in a year.

It was only a year ago that the “mega bank merger” between CIMB Group Holdings Bhd, RHB Capital Bhd and MBSB was called off, after six months of talks, as the parties decided that it wasn’t a good time to merge as the economy got progressively sluggish.

Analysts don’t rule out MBSB looking for another Islamic bank to merge with down the line, if the plan with Bank Muamalat fails to materialise. For now, they say MBSB can stand on its own even as it continues with its measures to close the gap to become a bank.

The measures include a two-year impairment programme, which MBSB embarked on in the final quarter of 2014, that involves assessing its non-performing loans based on the banking industry standards of three months in arrears. This means that it has been making heavy provisions over the last few quarters, which has weighed on its bottom line but will nevertheless see it emerge leaner and cleaner by 2017.

MBSB is likely to need capital injections to keep it competitive, and analysts say there’s no reason the EPF will not continue to support any cash call by MBSB.

For Bank Muamalat, the situation is a little trickier. DRB-Hicom must pare its stake in the bank to at least 40% from its present 70% by the end of next month. Bank Negara has given the conglomerate, which is controlled by businessman Tan Sri Syed Mokhtar Albukhary, several deadline extensions to do so. It is understood that the February deadline is the final extension.

With the deadline looming, DRB-Hicom looks to be running out of options. As banks look to boost capital levels ahead of tighter regulatory requirements, industry sources wonder if Syed Mokhtar will be able to support capital injections into Bank Muamalat in the future. His DRB-Hicom is currently struggling amid a weaker economy.

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