APAC’s Islamic Banks Surpassing Peers Amidst Challenges

S&P Global Ratings forecasts that Islamic banks in the Asia-Pacific region are set to exceed the growth of their conventional counterparts, even amidst potential economic adversities. This growth trajectory is primarily bolstered by the significant increase of Islamic banking assets in Southeast Asia, representing approximately 80% of all Sharia-compliant assets within the Asia-Pacific region.

According to the report published by S&P Global Ratings on May 22, these Islamic banking assets are expected to grow about 8% over the next two years. Moreover, Islamic banks are poised to capture a larger market share. For instance, in Malaysia, which holds the largest Islamic finance market in the region, it is predicted that these banks will hold 45% of the market share by 2026. Similarly, in Indonesia, the growth rate for Islamic banks is expected to be between 15%-18%, leading to a 10% asset share by the same year.

S&P Global Ratings credit analyst Nikita Anand posited that the Islamic banking sector in the Asia-Pacific region will remain concentrated. She elaborated that while growth rates at the sector level may decelerate, the financing growth of Islamic banks is still projected to surpass that of conventional banks, thus fostering a gain in market share.

With 20.7% of $1.9 trillion in global assets as of the end of 2022, Asia-Pacific ranks as the second-largest Islamic finance market, with the Gulf Cooperation Council leading at 68.3%. Islamic banking entails financial operations compliant with Islamic religious law or Sharia, which prohibits interest. As an alternative, Islamic banks share profits and losses with their customers instead of levying interest.

S&P Global Ratings highlighted the healthy capitalization of major Islamic banks in the region. These banks, mainly operating in core markets like Malaysia and Indonesia, are equipped to handle unrealized losses due to their conventional business models, which primarily consist of government securities. Moreover, these banks boast strong capitalization and stable retail deposit bases.

However, the report cautions that the profitability of Islamic banks in the region will be contingent upon the speed at which policy rates rise, along with the impact of these increases on financing rates and funding costs.

In Malaysia, Islamic lending is predominantly managed by subsidiaries of large conventional banking groups. For instance, Maybank Islamic Bhd., a subsidiary of Malayan Banking Bhd., controls 26.4% of the gross financing market share. CIMB Islamic Bank Bhd., under CIMB Group Holdings Bhd., accounts for 13.2%, and RHB Islamic Bank Bhd. under RHB Bank Bhd., represents 9.9% of the market share. The proposed acquisition of Malaysian Industrial Development Finance Bhd. by Malaysia Building Society Bhd. is expected to establish a comprehensive Islamic banking service in Malaysia.

Regulatory incentives in Malaysia, aimed at bolstering environmental, social, and governance financing and issuances, have been supportive of the growth of Islamic banks. Under such regulations, 18% of total financing is allocated to priority sectors, with small and medium-sized enterprises receiving the lion’s share. This is also expected to increase the issuance of sustainability sukuk, or Islamic bonds.

In Indonesia, PT Bank Syariah Indonesia Tbk dominates the Islamic banking market. Profitability for Indonesian Islamic banks is likely to improve as financing rates rise to keep pace with policy rate hikes, thereby boosting margins. However, the report warns of a likely increase in nonperforming assets in Malaysia and Indonesia, although largely secured exposures could mitigate losses should asset quality deteriorate.

In Brunei, Islamic banks have successfully maintained a 50% market share. High energy prices are expected to bolster the asset quality of the country’s banks, keeping nonperforming assets largely stable. However, in Bangladesh, despite holding a 25.