Banks' efforts to improve funding profiles could yield results in three to five years. The funding profiles of Malaysia's Islamic banks will likely stay weaker than that of the overall sector, reflecting structural weakness in attracting low-cost retail deposits. The funding costs of Islamic banks are highly sensitive to rate increases. This is because of their lower share of low-cost demand and savings deposits (27% compared with the sector's 31%) and a higher share of costlier wholesale deposits (71% compared with the sector's 64%).
What's happening
Islamic banks saw a sharper contraction in net financing margins in 2023 than conventional banks. This was due to the upward repricing of term deposits and intense competition of deposit rates. The decline was sharper than the contraction in net interest margins at conventional banks. For the Islamic bank subsidiaries of rated Malaysian banks, margins contracted 34 basis points on average compared with 27 basis points at the group level. The profitability of Malaysian Islamic banks is generally in line with that of the overall banking sector, but in 2023 the gap widened, with return on assets of 1.0% versus the 1.2% for the sector.
Why it matters
Funding challenges could constrain Islamic banks' growth and profitability. Islamic banking drives Malaysia's growth story given many large banks adhere to an "Islamic first" strategy. Financing growth could moderate if growth in low-cost deposits continues to lag.
Profitability could stay lower than the sector in 2024 as well. Elevated deposit rates are exacerbated by intense competition for pricing household loans and financing in Malaysia's saturated banking sector. Islamic banks also tend to have a higher share of hire-purchase financing. Given these are fixed rate, margins don't expand as quickly because adjustments to financing rates only happen with a significant lag to interest rate hikes.
Standalone Islamic banks face elevated funding risks. In our view, Islamic bank subsidiaries of large banking groups are better positioned to manage this risk as they can benefit from intra-group funding. Standalone Islamic banks are on a relatively weaker footing and may face a contraction in their market share.
What comes next
Management actions could gradually fix the problem. Banks continue to ramp up efforts on growing Islamic deposits through promotional rates, campaigns, better service, and ease of migration of low-cost demand and savings accounts from conventional to Islamic. The sector has also been gradually diversifying its funding sources; for example, by increasing funding from investment accounts.
Related Research
- Sector Review: Asia-Pacific Is Ripe For Islamic Banking Development, May 9, 2024
- Malaysian Banking Sector Review: Standing Firm In The Face Of External Headwinds, April 22, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Nikita Anand, Singapore + 65 6216 1050; nikita.anand@spglobal.com |
| Secondary Contact: | Geeta Chugh, Mumbai + 912233421910; geeta.chugh@spglobal.com |
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