Malaysia banking sector globally respected

An early adopter of sharia-compliant financial systems, Malaysia is now reaping the benefits as it continues to consolidate its global lead in Islamic finance. Following 23 years since commercial banks were allowed to offer Islamic banking products, the sector has emerged as a formidable force in providing funding to the Malaysian economy and beyond, creating additional high value at home and abroad. By the end of 2015 the sector had more than surpassed the government’s original target of increasing Islamic banking sector’s share to 20% of the total banking assets and establishing Kuala Lumpur as a centre for Islamic banking services.

Capacity Development

The development of the IFS sector was aided greatly by strong support from the central bank, Bank Negara Malaysia (BNM), as well as the establishment of the Islamic Financial Services Board (IFSB) in 2002, which helped to develop and implement a set of clear regulatory standards. These efforts have paid off. Thomson Reuters’ “State of the Global Islamic Economy Report 2015/16” ranked Malaysia as a world leader in Islamic finance development and the top global Islamic economy. The ranking was based on criteria such as level of governance, transparency, education, finance, corporate social responsibility and overall awareness.

Arguably its biggest advantage has been in human resources and skill development. These days Malaysia has the highest concentration of professional development programmes for Islamic finance professionals in the world. In addition, Malaysia is the only country that has a university dedicated entirely to Islamic finance, the International Centre for Education in Islamic Finance. As a result, it has the most sharia scholars who are able to serve on the boards of Islamic banking institutions.

Market Structure

The market is currently served by as many as 16 players, of which 10 are local and six foreign. All leading conventional banks, Maybank, CIMB, RHB Banking, Hong Leong and Public Bank, have established separate Islamic bank subsidiaries following the enactment of the Islamic Banking Act in 1983 and subsequent liberalisation of the sector. While Islamic divisions benefit from conventional banks’ infrastructure, branch network and, in some cases, expertise, they are run as separate entities with their own funding, capital and supervision. Foreign banks HSBC, Standard Chartered, Kuwait Finance House and OCBC Bank are also active in the sector, having been given an Islamic banking licence by the regulator.

Jaseem Ahmed, secretary-general of the IFSB, told OBG, “Islamic finance has been part of Malaysia’s long-term economic development strategy over the last 30 years. Malaysia recognised that Islamic banks needed government support in the same way as conventional banks, via a full array of financial markets and instruments to support them.”

Entering Mainstream

BNM statistics show that total assets held by the Islamic banking system were RM537.08bn ($132.9bn) by March 2016, which is equal to 22.7% of the entire banking system. This compares to just 10.5% in 2004, when government efforts to develop the sector were kicked into high gear. In terms of actual credit extended to the economy, Islamic banking institutions now account for just under a third of total lending activity at around 27% by March 2016, compared to 22.4% in 2011.

At the same time Malaysia is the leading destination for issuance of sukuk, or sharia-compliant bonds, by a long way. In 2015 it was responsible for 52% of the $34.8bn international sukuk market – a position it is holding firmly against stiff competition from leading financial centres such as Dubai, London, Singapore, Doha, Bahrain and Riyadh. Although as many as 27 countries have issued sukuk, Malaysia is estimated to account for almost two-thirds of total gross value, according to the IMF. The Malaysian ringgit is still the dominant currency of issuance of sukuk, surpassing the US dollar.

Recent Highlights

In line with the rest of the financial sector Malaysian Islamic banks were on their guard to shake off a deterioration in business sentiment linked to falling oil prices and weakening demand for real estate, as well as declining revenues from the palm oil sector. The government sent a powerful message to Islamic finance investors in April 2015, when it issued a $1.5bn dual-tranche bond just as there was concern in the market it may lose its coveted “A” rating. What was notable was that the issuance was split into a $1bn, 10-year tranche and a $500m, 30-year maturity. The 30-year sukuk bond became the longest tenure issued by any sovereign, thus establishing a benchmark for other sovereign issues and reaffirming Malaysia’s pioneer status in this important global niche.

The issue was oversubscribed six times, with as many as 450 bidding accounts providing an order book of $9bn. The message was clear and comforting. Malaysian sovereign will have no problem finding demand for long-dated sukuk paper if alternative sources of funding are needed.

The composition of the investor base was also reassuringly diverse. Of the total of $500m only 15% was subscribed by Malaysian investors. The largest share was awarded to investors from Asia, excluding Malaysia, who subscribed to 35% of the sukuk issue. US investors accounted for 29%, followed by Europe with 19% and Middle East at 2%. In terms of investor profiles the biggest share of 45% went to fund managers, 17% to insurers, 17% to other central banks and sovereigns, and 12% to pension funds. The sale was based on a sharia arrangement known as wakala, which allows investors to authorise a special purpose vehicle to act on its behalf.

Another recent milestone achieved in 2015 was a similar placement carried out by Malaysia’s state-owned energy firm, Petronas, which issued a $5bn bond, $1.25bn of which was sharia-compliant. Separately, another Malaysian oil and gas company, SapuraKencana, issued a $200m sukuk under its multi-currency programme. It was the first time that certificates were denominated in US dollars rather than ringgit and sold entirely to a local investor base.

Migrating Deposits

Another major development in 2015 was the much anticipated migration of Islamic deposits held by Islamic banks into investment accounts in line with sharia concepts known as mudarabah, or profit sharing, and wakalah. The requirement was mandated by the Islamic Financial Services Act of 2013 and gave banks until June 2015 to complete the transition. The regulator has asked all Islamic banks to educate their customers about the difference in risk profile and returns offered by deposits as opposed to investment accounts and to obtain consent from customers to shift their funds into either one of the newly classified accounts. In a March 2014 statement the Association of Islamic Banking Institutions Malaysia said, “The differentiation will allow the institutions to develop a wider range of products, for both classifications, to meet the diverse needs of customers.”

There was some concern about potential cost implications and the impact on Islamic banks’ profitability expressed in a March 2014 report from local news site The Star Online. The report claimed there was the risk of a spike in operating costs and further pressure on net interest rate margin as investment accounts, unlike deposits, will not be protected by the Malaysia Deposit Insurance Corporation. According to BNM, the sector held a total of RM502.9bn ($124.5bn) in deposits, of which around 9% are classified as investment accounts. Despite higher yield, the risk of uninsured deposits proved to be a major factor in convincing customers to stick to lower-yielding deposit accounts. On the whole, Malaysian Islamic banks now account for 30% of the entire banking sector, making them systemically highly important and sensitive to any potential losses.

Performance Indicators

Current data from BNM shows that despite fast growth Islamic banks are managing their risk to keep their balance sheets in solid shape. Just like the rest of the Malaysian financial system, Islamic banks enjoy high capital ratios. At the end of 2015, the sector’s total capital ratio stood at 16.1%, while Tier 1 capital was 12.3%. This compares to 13.8% and 12.8%, respectively, for conventional banks. Return on assets within Islamic banks is slightly lower than at conventional banks at 1%, compared to 1.3% at conventional banks.

This lower profitability is partly explained by a higher growth rate and the higher yield expected by customers who are attracted to Islamic products because of its profit-sharing value proposition. Islamic banks also appear to be better at managing risk than conventional banks. Their net impaired financing ratio stood at 0.9% at the end of 2015, compared to 1.2% within the conventional segment.

Although there has been some criticism that Islamic finance and banks compete for the same segments and customers as conventional banks, their risk appetite appears to be somewhat different and focused more on retail and development-oriented projects. BNM data show that in terms of purpose the highest concentration of loans amongst Islamic banks was for the purchase of residential property, followed by working capital and purchase of passenger cars. Reviewing sector exposure the highest concentration was in the household sector, which accounted for RM236bn ($58.4bn), which was equal to 48% of total loan portfolio.

Takaful Sector

Islamic banks are well supported by their sister organisations, takaful, or sharia-compliant insurance, companies which have played an important role in supporting the development of Islamic finance in Malaysia since the 1980s. There are 11 takaful players in the market, of which eight specialise in family and general takaful businesses and three in family takaful. Combined they held a total of RM24.7bn ($6.1bn) in fund assets, accounting for 9.4% of insurance business, according to BNM. Family was by far the biggest segment, representing 87% of all assets. Net contributions income for takaful stood at RM6.8bn ($1.7bn) at the end of 2015, with family accounting for 75% of the total, according to BNM.

The Malaysian Takaful Association expects that the growth rate in terms of the number of policies is set to increase by 10% in 2016 and will reach 5.05m. Bloomberg reported in April 2016 that Ahmad Rizlan Azman, chairman of the association, said that insurers entering the micro-takaful market and the liberalisation of commission structures are the biggest drivers. Takaful is also expected to benefit most from the Malaysian government’s effort to introduce insurance protection in rural areas that suffer from floods, fires and other hazards. By 2020 the government wants insurance penetration to rise from current 55% to 75%, with takaful likely enjoying the biggest share of that growth.

Financial Inclusion & Innovation

Apart from delivering faster credit growth rates, the Malaysian Islamic banking sector is a beacon of hope for policymakers striving to improve financial inclusion. Through its risk-sharing and asset-linked financing, as well as its greater focus on rural communities, Islamic finance is set to play a crucial role in providing an attractive alternative to conventional banks. This is also reflected in the number of sharia-compliant microfinance programmes that exist in Malaysia. It is also an important channel for redistribution of wealth through zakat, or charitable donations.

“The whole area where we have debt financing and high interest rates for small enterprises and individuals is an area which has been dominated by very innovative thinking but now needs to be revisited because the burden that debt imposes is so high,” Ahmed told OBG. “Here Islamic finance has a major role to play, but it is still at a very early stage.”

A new innovative platform that has recently been introduced in Malaysia is equity crowdfunding. Regulators and market participants expect that it will be a popular platform for Islamic crowdfunding projects, especially those involving social and community projects where profit is a secondary consideration.


An ongoing economic recovery in 2016 should benefit Islamic banks and takaful players as incomes set to improve in rural and urban areas exposed to palm oil, energy and commodity sectors. With credit and asset growth likely to be faster than within the conventional finance segment, Islamic banks are likely to increase their market share to 27.3% by the end of 2016. By 2020 the sector’s share is expected to be above 30%, taking a significant share of the corporate and sovereign bond market. Equally, Islamic banks and takaful are expected to hold their own in the small and medium-sized entrepreneurs and retail segments, extending funding to more risky clients in socially sensitive areas. Though non-performing loan ratios are likely to increase, Islamic banks on the whole remain well capitalised and ready to absorb cyclical losses. Their capital buffers allow to maintain current growth levels for at least three to five years, with the biggest hurdle on the horizon being overall high household indebtedness and a falling savings rate. Meanwhile, the Malaysian sukuk market is expected to remain strong with demand outstripping supply of new instruments. Issuance of new instruments is likely to be dominated by both sovereign and corporate players, and in sectors such as infrastructure, utilities and financial services.

You have reached the limit of premium articles you can view for free. 

Choose from the options below to purchase print or digital editions of our Reports. You can also purchase a website subscription giving you unlimited access to all of our Reports online for 12 months.

If you have already purchased this Report or have a website subscription, please login to continue.

The Report: Malaysia 2016

Banking & IFS chapter from The Report: Malaysia 2016

Cover of The Report: Malaysia 2016

The Report

This article is from the Banking & IFS chapter of The Report: Malaysia 2016. Explore other chapters from this report.

Covid-19 Economic Impact Assessments

Stay updated on how some of the world’s most promising markets are being affected by the Covid-19 pandemic, and what actions governments and private businesses are taking to mitigate challenges and ensure their long-term growth story continues.

Register now and also receive a complimentary 2-month licence to the OBG Research Terminal.

Register Here×

Product successfully added to shopping cart