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APAC Islamic banks set to outpace conventional peers despite headwinds – Ratings


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APAC Islamic banks set to outpace conventional peers despite headwinds – Ratings

Islamic banks in Asia-Pacific will outgrow conventional banks despite economic pressures, according to S&P Global Ratings.

Islamic banking assets in Southeast Asia, which make up 80% of sharia-compliant assets in Asia-Pacific, will rise about 8% over two years, Ratings said in a May 22 report. Islamic banks will gain market share, reaching 45% in Malaysia, the biggest Islamic finance market in the region, by 2026. In Indonesia, Islamic banks will grow 15%-18% to about 10% of assets by 2026.

"The Islamic banking market in Asia-Pacific will stay concentrated, with Malaysia forming the lion's share," Ratings credit analyst Nikita Anand said. "Even as growth moderates at the sector level, financing growth of Islamic banks will continue to outshine conventional banks' credit growth, facilitating market share gains."

Asia-Pacific is the second-largest Islamic finance market, with 20.7% of $1.9 trillion in global assets as of the end of 2022. The Gulf Cooperation Council has 68.3%. Islamic banking refers to financial activities that adhere to Islamic religious law. Under sharia, interest is prohibited, so Islamic banks share profits and losses with their customers instead of charging interest.

Healthy capitalization

Ratings noted that major Islamic banks in the region could withstand unrealized losses because conventional business models with government securities make up most of their investments. Islamic banks in core markets such as Malaysia and Indonesia have strong capitalization and stable retail deposit bases, it said.

Profitability for Islamic banks will vary in the region depending on how quickly policy rates increase, how those increases are passed through to financing rates and funding costs.

In Malaysia, subsidiaries of large conventional banking groups are the biggest Islamic lenders. Malayan Banking Bhd.'s Maybank Islamic Bhd. controls 26.4% of the gross financing market share. CIMB Group Holdings Bhd.'s CIMB Islamic Bank Bhd. accounts for 13.2%, and RHB Bank Bhd.'s RHB Islamic Bank Bhd. represents 9.9%.

Malaysia Building Society Bhd.'s proposed acquisition of Malaysian Industrial Development Finance Bhd. will establish a full-service Islamic bank in Malaysia.

Supportive regulation

The report also noted that for Malaysian Islamic banks, where regulators support environmental, social and governance financing and issuances, 18% of total financing goes to priority sectors, with small and medium-sized enterprises receiving the most. Regulatory incentives aim to increase the issuance of sustainability sukuk, or Islamic bonds, it said.

PT Bank Syariah Indonesia Tbk dominates Indonesia's Islamic banking market. For Indonesian Islamic banks, profitability can improve as financing rates rise to match policy rate hikes, boosting margins.

The report warned that nonperforming assets would likely increase in Malaysia and Indonesia. However, largely secured exposures could limit losses if asset quality declines. Credit quality in both countries depends on employment conditions, given the high share of consumer financing.

Ratings noted Islamic banks have maintained a 50% market share in Brunei, and the country's banks' asset quality stands to benefit from high energy prices, with nonperforming assets remaining largely stable. In Bangladesh, Islamic banks, with a 25.8% share of deposits, face low profitability and capitalization, reflecting the broader banking sector, it said.