Islamic banks continue to drive Malaysia’s overall loan growth, profitability intact but outperformance will be limited

Published on 20 Mar 2024.

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Malaysian Islamic banks are expected to remain the primary engine of financing growth in the domestic banking sector. “Spurred by the ‘Islamic First’ strategy implemented by major banking groups, Islamic financing contributed an average of 75% of the system’s loan growth in the past five years,” said Sophia Lee, RAM Rating’s Co-Head of Financial Institution Ratings. As at end-2023, gross Islamic financing represented 42% of total loans in the banking sector, more than double its share over a decade ago. 

RAM Ratings maintains a stable outlook on the Malaysian Islamic banking industry, supported by a projected economic growth of 4.5% to 5.5% in 2024 and our expectations that the overnight policy rate will still hold steady. Our key expectations for the industry in 2024, as highlighted in our latest commentary, Banking Insight: Staying the course, include the following:

  • Islamic financing growth to moderate to around 7% (2023: +7.9%)
  • Industry’s gross impaired financing (GIF) ratio to hover below 1.6% (2023: 1.5%)
  • Funding and liquidity position to remain healthy 
  • Profitability to stay intact but limited due to tough operating climate and cost pressures
  • Capitalisation to remain sturdy

Although slower than the year before, the Islamic financing industry registered commendable financing growth of 7.9% in 2023 (2022: 12.4%), which far outpaced that of its conventional counterparts (2023: 3.5%; 2022: 1.5%). The credit slowdown last year was due to the contraction in financing for the purchase of Amanah Saham Bumiputera units and slower business financing growth amid the higher interest rate environment. Subdued global trade and inflationary pressures added to these challenges. The impending rationalisation of subsidies in 2H 2024 could further cast a shadow over household credit demand, a key driver of industry financing growth. As such, we project a more moderate uptick in financing this year. 

The asset quality of Islamic banks remained strong in 2023. The industry’s GIF ratio clocked in at 1.5% as at end-2023 (end-2022: 1.6%), below the banking system’s 1.65% due to the faster growing base. The system’s credit cost ratio improved to an annualised 21 bps in 9M 2023 (2022: 27 bps), partly due to some management overlay releases. With the retargeting of subsidies, household disposable incomes will likely reduce and this could impact debt servicing. Despite that, reported asset quality indicators of Islamic banks should stay sound in 2024, backed by banks’ prudent underwriting and the robust labour market. The industry also boasts a sturdy common equity tier-1 ratio of 14.0% as at end-2023, which should provide a sufficient buffer against credit stresses. 

Customer funding (i.e., deposits and investment accounts) rose at a milder 6.8% last year (2022: 10.0%), lagging financing growth. Notably, Islamic term deposits accounted for 84% of the entire banking sector’s fixed deposits. Relative to conventional banks, the proportions of current account and savings account (CASA) deposits and retail deposits constituted a smaller proportion of funding. Investment accounts (IAs), meanwhile, were up 16.0% y-o-y (2022: 6.1%), with the bulk of the increase coming from restricted IAs – funding largely extended by parent banks. These continue to support the sector’s funding and liquidity position, which we envisage to stay healthy.

Most Islamic banks experienced an acute contraction in net financing margins (NFMs) in 2023, though more pronounced than the conventional banks partly due to the lower percentage of CASA deposits. The industry’s NFM narrowed to an annualised 1.84% in 9M 2023 from 2.21% in 2022, primarily owing to deposit competition and upward deposit repricing. The Islamic banking industry’s overall pre-tax return on risk-weighted assets slid to an annualised 2.12% for 9M 2023 (2022: 2.69%). While we expect the industry’s profitability to stay intact, upside will be limited because of the tough operating environment and elevated operating costs.

In January 2024, AEON Bank (M) Berhad became Malaysia’s first Islamic digital bank (and the third digital bank) to launch its digital banking operations. AEON Bank holds one of two Islamic digital banking licences awarded by Bank Negara Malaysia in 2022, the other held by a consortium led by KAF Investment Bank Berhad. Digital banks will bring new dynamics to the domestic banking sector which will see an increasingly digital pivot to provide greater access to financing. Despite the strong competition for deposits seen since their launch, we do not expect them to pose any threat to incumbent banks in the near term. 

As the momentum for sustainable financing in the banking sector gains traction, we also see Islamic banks playing a key role in advancing inclusive financing, in line with their value-based intermediation (VBI) principles. Based on the latest available data as at end-2022, VBI financing made up about 11% of the total financing amount, of which 79% were related to social financing while the remainder pertained to net zero and green-related financing. 

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


Analytical contacts
Jeremy Noel Paul
(603) 3385 2556

Wong Yin Ching, CFA
(603) 3385 2555

Sophia Lee
(603) 3385 2619

Media contact
Sakinah Arifin
(603) 3385 2500


About RAM Rating Services Berhad (RAM Ratings)

Established in 1990, RAM Ratings is a leading credit rating agency registered under the Securities Commission’s Guidelines on Credit Rating Agencies, 2023. In addition to the provision of credit ratings for corporate bonds and sukuk and their issuers, RAM Ratings also provides research and publications on Islamic finance, fixed income and macro-economic and industry analysis as well as data analytics relating to credit risk, counterparty assessments and other related domains. 


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