by DASHVEENJIT KAUR/ pic by BLOOMBERG

ISLAMIC finance will likely contribute further to Malaysia’s banking system — supported by Bank Negara Malaysia (BNM), which provides a level playing field — and banks that continue to promote Islamic products, according to Fitch Ratings Inc.

The international credit ratings agency expects Islamic financing to grow faster than conventional loans in the medium term, but likely fall short of BNM’s 40% target of all loans in the banking system for 2020.

The Covid-19 outbreak poses some downside risks to growth and asset quality, including those of Islamic banks, Fitch added.

“We view Islamic banks’ loss-absorption buffers as providing adequate support to withstand the near-term challenges,” it said.

To recap, Malaysian Islamic banks’ financing grew by 8.3% in 2019, outpacing conventional loans growth of 1.6%, bringing the share of Islamic financing to total system loans to 35%.

Fitch expects the impact on Islamic banks’ asset quality from Covid-19 to be similar to the conventional banks, given a comparable financing mix.

“However, banks’ and the government’s relief packages should help mitigate near-term consequences.

Profitability is likely to face added pressure from BNM’s recent policy rate cut, along with monetary policy easing in many Asia-Pacific markets, in addition to existing domestic market competition, it added.

Islamic banks’ credit profiles, according to Fitch, should remain broadly steady in the near term, though the rating agency sees risks to asset quality and profitability should the virus prolong.

“The Islamic banks’ asset-quality advantages over conventional banks have now closed, as Islamic financing has seasoned after periods of rapid growth.

“The impaired-financing ratio modestly increased to 1.4% by end-2019 (2018: 1.3%), while provision coverage fell to 86% (2018: 108%),” it added.

The financing or deposit ratio, which includes investment accounts, was stable at 94% at end-2019, Fitch said.

The proportion of longer-term fixed-deposit balances has grown in anticipation of the net stable funding ratio requirements in July 2020.

The common equity tier 1 (CET1) ratio declined to 13.3%, due to higher upstream dividend at one of the major Islamic banks, but still reflects an acceptable buffer against a potential spike in credit costs, Fitch noted.

Fitch also highlighted that Malaysia hosts the world’s largest sukuk market, with a 39% share of global outstanding sukuk and the nation comprises around 11% of global Islamic bank assets.

BNM finalised the value-based intermediation framework in late 2019, an Islamic equivalent of sustainable financing and one of the firsts for the sector in the region.

Malaysia is a leader among other Islamic finance hubs for financial technology regulatory developments and digitalisation, the rating agency said.