Per the source, Gunners boss Arsene Wenger is keen on Denayer following injuries to centre-backs duo Per Mertesacker and Gabriel during pre-season.
Wenger was planning to bring in Denayer to ease his defensive crisis but the 21-year-old prefers a move to Galatasaray where he is already settled in after spending last season at the club.
The North London based outfit may be able to tempt City if they were to match his £12 million asking price.
Galatasaray would be unable to match his valuation due to FFP – the Istanbul giants have been banned for a season from European football and cannot spend more than their revenues over the summer if they want to avoid a second season ban.
The Lions want Denayer on loan as confirmed by club sporting director Levent Nazifoglu.
Sporting director Levent Nazifoglu told Turkish-football.com: “Denayer settled in well last season and we want him back but it all now depends on what he says and what Manchester City decide.
“We want him and so does the manager and City know this.”