Malaysia’s Islamic banks geared up against COVID-19 headwinds

Published on 25 Mar 2021.

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RAM Ratings maintains our stable outlook on the Malaysian Islamic banking sector, in line with our view on the overall domestic banking system. Our main expectations for the industry in 2021, as outlined in our annual publication, Islamic Banking Insight, include the following:

•    Islamic financing to drive overall banking system’s credit expansion in 2021; financing to widen by 7%, compared to 2% by conventional banks. Growth is underpinned by household financing. 
•    Asset quality indicators to be upheld by forbearance measures; Islamic banks’ gross impaired financing (GIF) ratio expected to rise to about 2% by end-2021 (end-December 2020: 1.3%), which still fares better than that of the conventional banks’ at around 2.5%.
•    Sound liquidity position; higher current and savings account (CASA) balances largely aided by financing moratorium.  
•    Profitability to improve with broader margins and absence of modification losses, although provisioning will remain elevated.
•    Still-strong capital position to cushion pressure on asset quality. 

The COVID-19 pandemic has wrought unprecedented havoc on the domestic economy. Nonetheless, Malaysia’s Islamic banking sector managed to post a respectable 8.1% financing growth in 2020, while conventional banks merely inched up 1%. Roughly similar to growth in 2019, the expansion in 2020 was propped up by the six-month blanket financing repayment moratorium and government funding schemes. Credit growth of the overall banking system continues to be fuelled by Islamic financing underpinned by the Islamic First agenda adopted by several major banking groups. The latter contributed to more than 80% of total incremental loans in 2020. With the inclusion of financing from development financial institutions, the overall exposure to Islamic financing is estimated to have exceeded Bank Negara Malaysia’s target of 40%.

While the second movement control order (or MCO 2.0) has inflicted less damage on businesses than earlier restrictions, it has dampened economic recovery. “We have therefore pencilled in a softer financing growth of about 7% for the Islamic banking industry this year,” explains Wong Yin Ching, RAM’s co-head of Financial Institution Ratings.

The local Islamic banking sector’s financing quality fares better than conventional banks’. Its GIF ratio stayed sound, clocking in at 1.35% as at end-January 2021 (end-December 2019: 1.45%). Even so, the high degree of uncertainty over the trajectory of the coronavirus outbreak has cast a shadow over the sector’s asset quality. We project a GIF ratio of about 2% for the industry in 2021. “Impairments are likely to peak only in 2022, after banks’ relief measures have ended. The proportion of financing under targeted repayment assistance and restructuring and rescheduling is estimated to be in the low to mid-teens” observes Sophia Lee, RAM’s co-head of Financial Institution Ratings. 

Islamic banks have been prudently and pre-emptively fortifying their provisioning buffers. The sector’s annualised credit cost ratio surged to 0.5% in 9M 2020 (2019: 0.1%), broadening its GIF coverage – with regulatory reserves – to 127% as at end-September 2020 (end-December 2019: 113%). Amid unrelenting credit headwinds, provisioning charges this year will stay elevated, albeit at lower levels. On the whole, this sector remains well capitalised against near-term credit stresses. Its common equity tier-1 capital and total capital ratios stood at a respective 13.8% and 17.9% as at end-January 2021. 

The system’s annualised pre-tax return on risk-weighted assets shrank to 1.6% in 9M 2020 (2019: 2.5%) on account of heftier proactive credit charges and modification losses. Islamic banks bore the brunt of modification charges given their higher share of hire purchase and fixed-rate financing compared to that of their conventional peers. That said, the Islamic banking sector’s net financing margin (excluding modification losses) remained intact at 1.9% despite the aggregate 125 bps of overnight policy rate cuts in 2020. We anticipate earnings pressure to ease somewhat in 2021, with the absence of sizeable modification charges and some margin uplift as most deposits would have been repriced. However, industry players’ ongoing efforts to beef up loss absorption buffers could still constrain profitability. 

Notably, the Islamic banking system remains highly liquid, with its liquidity coverage ratio standing at almost 129% by the end of January 2021. CASA balances have expanded amid the automatic financing moratorium and low interest rates, currently accounting for 25% of total customer deposits (end-December 2019: 22%). In preparation for compliance with the 100% net stable funding ratio requirement by end-September 2021, banks have been trying to garner more long-tenured fixed deposits. 

RAM’s Islamic Banking Insight is available at www.ram.com.my.


Analytical contact
Chow Kah Mun
(603) 3385 2501

Wong Yin Ching, CFA
(603) 3385 2555

Sophia Lee
(603) 3385 2619

Media contact
Padthma Subbiah
(603) 3385 2577

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Publication Date Published Category
Islamic Banking Insight 2021 25-Mar-2021 Banking Insight View PDF