They may not have seen Banjo as necessary because they already had Mario to fill the 3D platformer role for their systems.
That's also another factor.
I also imagine he still had to negotiate for the Proximity Mine, Cloaking Device and/or the Motion Sensor Bomb alongside Rare trophies, so I imagine this type of thing came up often in Melee's development even outside character selection.
I kind of wonder if Diddy's rights at the time were considered up in the air. For the Smash 64 "what if there was a smash 2" reader polls he put Diddy in the Rare category.
I think Rare at the very least had some rights to the Kongs and Kremlings they created. It seems like all of that was sold completely to Nintendo when the buyout happened.
https://www.ign.com/articles/2002/09/20/official-nintendo-ends-relationship-with-rare
Nintendo stated that it would retain the rights for all original properties including Donkey Kong, Diddy Kong and Star Fox. It made no comment on whether or not Rare would retain the Perfect Dark and Conker's Bad Fur Day licenses.