Can Leo and Banon be recruited in the World of Ruin?

You -could- cut down on the glitches that would necessarily happen, like anything with a Riding sprite, by simply making Leo/Banon un-recruitable until -after- you've done all the sidequests (or at least Cyan's dream sequence, have the game check for a 'completed Cyan's dream' flag). Additionally, you could make an event that triggers at all Chocobo shopkeep's dialogue that checks for Banon/Leo and says something like "Oh no, It seems some members of your party are TERRIBLE at riding Chocobos, they'll have to go home." and then remove them from the party.

I suspect that any event that removes them from the party will result in having to do the Recruitment event again. Which probably means there's no way to take them to Kefka's Tower due to the split-party nature of it. It also means that there's an unlimited supply of whatever Equipment they come with.

And if you only have -one- of them join in the WoR, then you'll at least have that one able to equip things.
By the way, I suspect that Leo's Equipment list is the same list as the Merit Award's "Heavy Armor" list.
If you remove the Imp status effect from the game, you may be able to assign the Imp Equipment list to Banon/another character.

No clue what to do about the Colosseum.
To get rid of the Banon dies->game over thing, you could just remove the code entirely (though then it wouldn't happen at the Lete River either).

They won't learn Spells (there's just no room for a Spell list from what I can tell), BUT you may be able to tweak the code that gives Gogo the ability to use any party character's learned Spells when he equips the Magic skillset. The way the code is currently set up, Gogo's method of spell use is actually the DEFAULT, and then the game disables it for other PC ID#s. You may be able to expand the range of numbers that uses Gogo's method (this would mean giving Umaro and Gau the same feature, but you could just -not- give them the Magic skillset). I haven't looked at it extensively, but it could be interesting.

I wonder if Health/Shock work in Fanatic's Tower?