Will DBS, Danamon deal collapse curb Indonesia M&A?

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A decision by Southeast Asia's biggest bank to quit a year-long pursuit of Indonesia's Bank Danamon highlights how tough the country's regulatory framework is and could deter other foreign banks from showing interest in the banking sector, Fitch Ratings said on Thursday.

Singapore lender DBS on Wednesday walked away from a $7.2 billion deal to buy Bank Danamon in what would have been Southeast Asia's largest banking takeover.

"We believe the collapse of the deal is likely to discourage some long-term foreign buyers looking to establish and build a local franchise," Fitch said in a report.

(Read more: DBS, Danamon bank deals collapses)

DBS said regulatory hurdles were the main reason from walking away from the deal, with Jakarta capping foreign ownership of banks at 40 percent – much lower than DBS's plan to buy a 67 percent stake.

Fitch said that owning a minority stake in Danamon would have made it difficult for DBS to achieve the same degree of integration in Indonesia that it has with its subsidiaries elsewhere in the region.

"Without majority control, no bank or any company would like that," Kevin Kwek, senior analyst at the brokerage Sanford C. Bernstein, told CNBC Asia's "Cash Flow."

"You don't have control and some of the other banks that already have stakes would equally be concerned as to whether any changes going forward would be retro-active and if they were, you would certainly take out a lot of interest in the local banking sector," he said.

(Read more: DBS optimistic of turnaround in China business: CEO)

Investment hit

The collapse of the bank deal is bad timing for Indonesia, where the foreign investment outlook has been hit by a spike in currency volatility, protectionist measures such as the tightening of import quotas, duties on exports of raw minerals and restrictions on foreign ownership of local mining firms.

Indonesia, once the darling of foreign investors, has also suffered from a fall in the appeal of emerging markets generally. Foreign investors have pulled roughly $2 billion from the stock market throughout June, according to government data.

(Read more: As the world turns, BRICs no longer a slam dunk)

There is concern that tighter control of the resource sector could spread to other areas.

"There's the sense that as a foreign player, you could end up in a situation where the playing field is not as level as you like," said Economist Intelligence Unit CEO Robin Bew.

"It's not sensible because places like Indonesia are going to need to be attractive to foreign capital, especially at this time when we are seeing growth slowing across the world," Bew added.

Still, Fitch said Indonesia's banking sector remained attractive.

"The country has low credit penetration relative to other fast-growing markets (India and China), an expanding middle class, a resilient economy, and high net interest margins," it said.

(Read more: An Asian economy's huge move to lure capital back)

"The cap on Indonesian bank ownership of up to 40 percent is still high by regional comparison. But foreign capital is necessary for the market to fulfil its potential; and can also bring better risk, transparency and governance discipline to the banking sector," Fitch added.

Blessing in disguise?

DBS, which has been keen to get a bigger slice of the fast-growing Indonesian market, on Thursday posted a 10 percent rise in second-quarter profit. CEO Piyush Gupta said that the bank would focus on expanding its business in Indonesia without chasing acquisitions.

The strategy could be more successful than a Danamon acquisition would have been, analysts said.

"This is actually positive in the sense that DBS can now re-focus its energy and capital to building businesses that would have likely been put on hold pending a decision on the Danamon deal," said Kwek at Sanford C. Bernstein.

By CNBC.com's Nyshka Chandran. Follow her on Twitter @NyshkaCNBC