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Malaysia Islamic Banking System Edges Towards Banking System Parity as Financing and Deposits Market Share Reach 40% and Total AUM Tops RM1.3 Trillion (US$298bn)

This year Malaysia marks the 40th anniversary of the introduction of the first Islamic Banking Act (IBA) 1983 in Malaysia which paved the way for the establishment of the flagship Bank Islam Malaysia Berhad in June of that year. The IBA has since then been superseded by the Islamic Financial Services Act (IFSA) 2013 and its updates in conjunction with the Shariah Governance Policy Document (SGPD) 2019. In the last four decades the Malaysian Islamic finance industry has gone from strength to strength setting government Islamic finance sector policy standards yet to be paralleled by any other country. In March 2023, Bank Negara Malaysia published its Annual Report for the Fiscal Year 2022. It confirmed the continuing upward trajectory of its Islamic banking sector, which showed remarkable resilience in the face of global polymorphic uncertainties, geopolitical challenges and economic shocks which precipitated an entrenched universal cost-of-living crisis fuelled by rising fuel and food prices exacerbated by resultant high levels of inflation. Mushtak Parker considers the current state of the Malaysian Islamic banking industry

Since it was introduced 40 years ago, Malaysia’s Islamic banking proposition by all the market metrics, continues its march towards reaching parity with its counterpart conventional banking system in terms of market share of the banking system and its two core components – financing and deposits and investment accounts.

The target set by successive governments is to reach 50% parity by 2025 for the country’s stated dual banking system policy, where an Islamic banking system operates side-by-side a conventional one, cooperating but bereft of co-mingling of funds and assets. That was the dream in 1983 of Al Marhoum Tan Sri Jafaar Hussein, the then Governor of Bank Negara Malaysia (BNM), the central bank, whose baton was eminently carried on by his later successor Tan Sri Zeti Akhtar Aziz, who largely steered the Malaysian Islamic finance industry to its current pre-eminence. The rest is history.

The policy is based on a natural progression and market development for the two systems, albeit the Islamic sector has enjoyed a fair bit of policy and regulatory handholding since it was introduced in 1983 by the government of Dr Mahathir Mohamed, underpinned by the desire to give customers a choice which banking system they use under Malaysia’s unique financial and social inclusion policy.

The handholding was necessary for various banking structural and socio-financial reasons of which improving the financial accessibility and experience of Malaysian aspirant and repeat pilgrims to the annual Hajj pilgrimage to Makkah Al Mukarramah was a prime driver. The other objective of adopting a unique dual banking system, in my discussions with Tan Sri Jaafar Hussein and his then adviser, the youngish Nor Mohamed Yakcop, was to give Malaysians a choice of which banking system to choose according to their values, conscience and convenience.

Four decades later, Malaysia has made impressive progress and is within reach of parity. According to the 2022 Bank Negara Malaysia Annual Report released at end March 2023, total assets under management (AUM) in Malaysia’s Islamic banking system increased from

RM1,236,289.1 million (US$280,783.38 million) in 2021 to RM1,316,167.8 million (US$298,925.27 million) in 2022, roughly 36.3% of the total assets of the entire banking sector.

The market share of Islamic financing reached 44.5% thanks to an annual growth rate of 10.8% (1.3% for the conventional sector) despite the impacts of the global economic downturn, the ongoing fallout of the coronavirus pandemic, and the supply chain disruptions and associated food and fuel price rises due to the Ukraine conflict. In value terms, the size of Islamic financing market share in the banking system increased from RM879.2 billion (US$199.68 billion) in 2021 to RM974.1 billion (US$221.24 billion) in 2022.

Similarly, Islamic deposits and investment accounts reached a 41.6% market share of total banking deposits and savings, growing year-on-year by 9.3% (1.2% for the conventional sector) from RM844.3 billion (US$191.76 billion) in 2021 to RM926.4 billion (US$210.40 billion) in 2022 for Islamic deposits and from RM124.6 billion (US$28.30 billion) to RM132.2 billion (US$30.02 billion) for Islamic investment accounts for the same period. The total capital ratio for both systems were around 18.75%.

The Takaful sector, however, continues to lag, albeit it also grew strongly but from a much lower base. Total market share of Takaful funds amounted to 13.4%, growing at 8.9% in 2022 from RM40.3 billion in 2021 to RM43.6 billion in 2022 for Family Takaful and RM5.5 billion to RM6.2 billion for General Takaful. Total market share for net contributions amounted to 23.0% growing at 18.1% in 2022 from RM10.9 billion in 2021 to RM12.7 billion in 2022 for Family Takaful and RM2.9 billion to RM3.6 billion for General Takaful.

According to Bank Negara Malaysia’s Islamic finance sector in 2022 contributed 1.2% to Malaysia’s GDP; RM185 billion (US$42.02 billion) through Sukuk issuances to fund real economic sectors (RM153 billion or US$34.75 billion in 2021); 11.9% business financing growth to meet business demand across economic sectors (2021: 8.8%); 9.4% household financing growth to meet household demand (2021: 8.9%); 24.7% growth financing disbursed to microenterprises and SMEs; and 20.1% sustained penetration rate of Family Takaful (2021: 18.6%).

Bank Negara in 2022 also pioneered the world’s first transaction-based Islamic benchmark rate developed in accordance with the international Principles for Financial Benchmarks. The introduction of the Malaysia Islamic Overnight Rate (MYOR-i), says Bank Negara Malaysia, will encourage greater Islamic financial product innovation and increase price transparency for Islamic financial contracts. In addition, partnering with the Securities Commission Malaysia, BNM has established the MIFC Leadership Council to further advance Malaysia’s Islamic finance agenda and provide greater industry stewardship.

The Islamic banking and Takaful industry, emphasised Bank Negara Malaysia Governor Tan Sri Nor Shamsiah Yunus, “sustained its growth in 2022, gaining further share of the overall financial system. The industry also remained resilient with strong capital buffers to support intermediation activities. This has enabled the industry to strongly support the funding needs of businesses including micro, small and medium-sized enterprises (SMEs), as well as households. Wider financial protection was also provided to various communities.”

All this augurs well for achieving the strategic priorities for Islamic finance in 2023, which include building resilience, sustainable and inclusive growth. “The strategic priorities for Islamic finance in 2023 aim to build greater ecosystem resilience as the system grows further in scale while promoting progressive, sustainable and inclusive growth. Our main focus is to spur innovation in value- based finance through making the most out of the full range of Shariah contracts in addressing contemporary socio-economic needs,” she added.

In addition, the aim is also to mainstream value-based finance and improving impact measures to achieve greater ecosystem alignment in VBI implementation; to strengthen ecosystem enablers to advance digitalisation of Islamic financial sector and deepen Islamic financial market and liquidity; and positioning Malaysia as an international gateway for Islamic finance with stronger industry stewardship to foster greater market dynamism.

Another focus is advancing the country’s halal trade and business and its connectivity to the Islamic finance industry. The halal sector has been recognised as one of the high-impact sectors that can drive growth of Malaysia’s economy. The sector is expected to contribute 8.1% to Malaysia’s GDP, with an export revenue of RM56 billion (US$12.72 billion) by 2025.

Islamic finance has made notable progress in supporting halal businesses over the years. The use of Islamic finance solutions by halal-certified companies has almost doubled since 2018 (2021: 41.3%; 2018: 21.9%).

This success was due to a range of efforts by the industry and Bank Negara Malaysia. These include offering tailored business solutions, promoting close partnerships between halal-related government agencies (such as Jabatan Kemajuan Islam Malaysia (JAKIM), Halal Development Corporation and Department of Standards Malaysia), as well as continuous engagements and awareness programs conducted all year round.

Bank Negara has been working closely with the World Bank in this respect. Last year the two entities published a joint report on “Islamic Finance and the Development of Malaysia’s Halal Economy” which provided six policy recommendations to advance the halal economy.

“The Bank is committed to work with the industry to implement these recommendations. This includes ensuring that Islamic finance is more integrated with the Halal economy, particularly in financing Halal trade and investment,” emphasised Governor Nor Shamsiah Yunus in the Annual Report.

A word of advice though! According to US-based Frost & Sullivan’s report last October on “Global Halal Economy Growth Opportunities,” the market for the global halal economy will likely witness impressive growth, reaching an estimated US$4.96 trillion by 2030 from US$2.30 trillion in 2020.

Growth opportunities, aside from traditional markets in Organization of Islamic Cooperation (OIC) member states, will increasingly emerge across non-OIC countries, driven by growing globalisation and awareness of Halal products and its preference by many non-Muslim consumers, and both policy momentum and private sector investments.

The gamechanger in the global Halal market is the Halal Products Development Company (HPDC), whose launch in Riyadh, Saudi Arabia last October signals the entry of Saudi sovereign wealth fund (SWF), the Public Investment Fund (PIF), into the Halal market. This can only augur well for an industry whose growth trajectory can only be upwards, globally.  

It is only natural that the Kingdom as the birthplace of Islam and the custodian of its two

holiest cities, Makkah Al Mukarramah and Madinah Al Munawarah, should be a policy, investment and market leader in the Halal economy, which includes financial services, travel and tourism, pharmaceuticals, fashion, creative arts, cosmetics and foodstuffs.

At the 2023 Islamic Development Bank (IsDB) Annual Meetings in Jeddah, Saudi Arabia, on 10-13 May, HPDC and PIF, with its very deep pockets, showed its intent in building Saudi Arabia into a ‘Global Halal Hub’ by signed a Memorandum of Understanding with the IsDB. Under the terms of the agreement, the two organizations will collaborate to promote and amplify opportunities within the Kingdom of Saudi Arabia’s halal sector and the halal industries of the IsDB Group’s 57 member states.

Malaysia’s Halal Development Corporation and other agencies, like others worldwide, must not see this as a threat, but a new socio-business opportunity to forge even greater synergies, collaboration and partnerships, that could take on the neo-colonial global brands and corporates on a ‘primus inter pares’ basis.

Mushtak Parker is an independent economist and financial writer based in London, UK.

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