More risk-taking needed as foreign players exit

Islamic banks in the country need to undertake more equity-based financing instead of the current debt-based financing

by BHUPINDER SINGH & NG MIN SHEN/ pic by MUHD AMIN NAHARUL

MALAYSIA’S robust Islamic finance sector needs to innovate and adopt more equity-based contracts to improve profitability going forward, as growth with the current model, although healthy, starts to taper off.

The sector’s growth has consistently outpaced that of the conventional banking industry and remains healthy in the near future, but the rising competition levels in a crowded market is leading to margin compression as the financing market increasingly becomes a scale business.

Industry experts said Islamic banks in the country need to take more risk by undertaking more equity-based financing instead of the current debt-based financing, but a shift in the business model will require fresh capital from shareholders.

The market dynamics is causing some foreign-based lenders to consider scaling down or exiting via mergers and acquisitions and outright sale of the business.

“What is going on with the foreign Islamic banks in Malaysia is not unique. Foreign banks in the Middle East are withdrawing or scaling back when their diversification effort don’t meet targets. The business model sometimes fails to attract the client base due to challenging market conditions and is likely the case for the foreign banks here as well,” Bashar Al Natoor, global head of Islamic Finance at Fitch Ratings Inc, told The Malaysian Reserve (TMR).

Among the foreign Islamic banks reported to be considering exiting Malaysia are Bahrain’s Bank Alkhair BSC (Alkhair International Islamic Bank Bhd) and Kuwait Finance House Bhd, Al Rajhi Banking & Investment Corp (M) Bhd, which is owned by Saudi Arabia’s Al Rajhi Bank, is currently in talks for a merger with Malaysian Industrial Development Finance Bhd.

Abu Dhabi’s sovereign fund Mudabala Investment Co PJSC, the second-largest shareholder of RHB Bank Bhd via a stake held by its unit, Aabar Investments PJS, sold its stake in the lender last week.

London-based Standard Chartered plc is also said to be considering selling or winding down its Islamic banking subsidiary here, Standard Chartered Saadiq Bhd, reportedly due to fierce competition from local players.

The move to exit comes despite almost all domestic Islamic banks expanding their earnings and assets in 2018, and the outlook remaining positive with Islamic finance expected to continue to anchor the overall banking sector’s growth.

Islamic banking financing grew by 11% in 2018 (2017: 10.3%) which is at a much faster pace than conventional loans which grew by 3.3% year-on-year, partly due to the sustained “Islamic first” strategy where new customers are offered Islamic products over conventional products, Fitch noted in a recent report.

The multinational rating agency expects growth rates to remain good, supported by the marketing approach, friendly demographics and a supportive regulatory environment.

As at end-January 2019, Islamic financing comprised some 32% of the overall system’s loans and the target is to raise the share to 40% by end-2020, which looks challenging due to a weaker economic environment.

For 2019, RAM Ratings expects Islamic financing growth to come in at around 10% to 11% — similar to last year, while asset quality indicators should remain resilient. Profitability is expected to remain stable as banks maintain a tight rein on operating expenses.

Funding Competition

“The foreign Islamic banks are probably exiting now hoping for a better value as growth going forward is likely to taper off and returns narrow. The sector can still rely on making a ‘halal premium’, but at some point of time the business model will need to innovate and take more risk to improve margins, by offering more equity-based financing contracts,” said International Centre for Education in Islamic Finance professor of finance Prof Dr Obiyathulla Ismath Bacha.

That might not be too far away. Fitch expects funding competition in the Islamic banking sector to intensify in the run-up to the implementation of the net stable funding ratio next year, noting Islamic banks’ lending rates are competitive and broadly in line with conventional banks’ rates, but Islamic deposit costs rose faster than average lending yields in 2018, pressuring margins.

The possible adoption of the value-based intermediation Shariah financing may make banks review their credit assessments and business models, Fitch stated.

“Financing that is deemed not directly supportive of real economic activities such as personal financing and debt consolidation or lending for trading purposes is discouraged under the guidelines. This may moderately dampen financing growth,” Fitch said.

Obiyatulla said local Islamic banking still prefers existing debt-based financing contracts (ijarah) as demand on capital requirements is lower to that required under the equity (mudarabah or musyarakah-based) contracts.

“There is some resistance to change as there is an element of regulatory capture, but Islamic finance globally needs more leadership from the government or supranational entities to push for the change,” he said.

The majority of Islamic lenders in Malaysia operate as subsidiaries of the larger conventional players, save for a few standalone players such as BIMB Holdings Bhd, MBSB Bank Bhd and Bank Muamalat Malaysia Bhd.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid  (picture) believes floating Islamic lenders as separate entities should be the way forward to raise fresh capital.

“This is very critical in order to ensure better price discovery for the share prices of listed Islamic financial institutions amid greater demand from investors who require Shariah-compliant stocks in their portfolio,” he told TMR.

Bank Statistics

According to data from the banks’ financial statements, Maybank Islamic Bhd is the largest Islamic lender locally with assets of RM226.01 billion as at end-2018.

In second place is CIMB Islamic Bank Bhd with assets worth RM121.06 billion, followed by Bank Kerjasama Rakyat Malaysia Bhd (Bank Rakyat) with RM106.89 billion.

As at end-2018, RHB Islamic Bank Bhd had assets of RM65.02 billion, Bank Islam had RM63.9 billion and Public Islamic Bank Bhd had RM62.17 billion. MBSB Bank’s assets amounted to RM45.43 billion post the takeover of Asian Finance Bank Bhd.

As at end-March 2019, AmBank Islamic Bhd’s assets stood at RM42.26 billion versus RM37.06 billion previously.

Bank Muamalat, which is not publicly listed, said in its official statement that its assets amounted to RM23.94 billion as at end-March 2018.

“There is less room to make mistakes on strategic decisions such as market niche, funding mix and operational matters. Technological change is rapid and requires Islamic banks to be more attentive to demand from the younger segment who are typically not brand loyalists. Additionally, regulators have become more open to non-traditional players such as financial technology players. So, the Islamic banks really need to buck up in order to stay relevant,” Mohd Afzanizam said.

The financial performance of the banks remains encouraging. BIMB, the parent of Bank Islam, saw its net profit rise 10% to RM682.06 million in the financial year ended Dec 31, 2018 (FY18), from RM619.84 million posted the year before, while FY18 revenue was 12.4% stronger at RM1.07 billion versus RM948.33 million recorded the year prior.

Bank Islam’s profit before zakat and tax (PBZT) increased 5.6% to RM810.3 million from RM767.1 million registered in FY17.

Maybank Islamic recorded a profit of RM1.93 billion in FY18, a 4.3% increase from RM1.85 billion the year prior, while its PBZT rose 10.6% to RM2.61 billion from RM2.36 billion in FY17.

CIMB Islamic saw its profit for FY18 grow 13.4% to RM1.07 billion from RM943.34 million recorded the year prior, while its PBZT was 11.4% higher at RM1.27 billion versus RM1.14 billion registered in FY17.

Public Islamic recorded a profit of RM473.997 million in FY18, up 15.5% from RM410.48 million posted the year before. Its PBZT was 15.6% higher at RM618.59 million last year compared to RM534.9 million previously.

RHB Islamic achieved a net profit of RM777.82 million for FY18, a 34.7% jump from RM577.32 billion the year prior, while its PBZT climbed 33.7% to RM922.15 million from RM689.77 million previously.

Hong Leong Bank Bhd’s net income from its Islamic banking business jumped to RM343.82 million for the six months ended Dec 31, 2018, from RM316.64 million recorded the year prior.

AmBank Islamic recorded a profit of RM324.25 million for the financial year ended March 31, 2019, up 19.6% from RM271.03 million last year. Its PBZT grew 22.4% to RM422.18 million from RM344.92 million in 2018.

MBSB Bank’s net profit fell 4.9% to RM117.96 million in FY18 from RM123.98 million the year before, while its PBZT surged 55% to RM853.57 million from RM550.73 million.

According to Bank Muamalat’s official website, the bank’s profit for the year ended March 31, 2018, expanded 1.7% to RM181.63 million from RM178.66 million the year before. Its PBZT grew 3.2% YoY to RM230.55 million from RM223.49 million.

Meanwhile, Bank Rakyat recorded a net profit of RM1.24 billion in FY18.