KUALA LUMPUR, March 1 — Malaysia’s Islamic banking sector continued to expand amid economic challenges brought on by the Covid-19 pandemic, said Fitch Ratings.

Malaysia also continued to be the largest Islamic banking, sukuk and takaful market in Asean, it added.

The credit rating agency said the share of Islamic financing in the banking system reached 37 per cent by the end of 2020 compared with 35 per cent at end-2019.

"Islamic financing contributed nearly all of the banking sector’s growth in 2020, driven by household financing and banks that promoted Islamic products as part of the ‘Islamic First’ strategy,” it said in a note today.

In 2021, Fitch expects the Islamic banking sector’s credit profile to remain stable with adequate loss-absorption buffers, despite near-term pressures on asset quality and profitability.

"We expect credit impairments to accelerate and credit provisions to remain high, following the loan moratorium and other loan repayment relief measures provided to vulnerable borrowers which have masked banks’ underlying asset quality in 2020,” it said.

In the medium term, it said the penetration of Islamic finance would likely rise due to economic recovery with the gross domestic product growth forecast at 6.7 per cent this year, a supportive regulatory environment, and banks that continue to promote Islamic products.

"Unique features of Malaysia’s Islamic banking industry include risk-sharing investment accounts (Mudarabah and Musharakah) which, among other areas, are not guaranteed under the deposit insurance scheme (DIS).

"On the other hand, investment accounts in other jurisdictions are typically covered by DIS or government guarantee.

"Although these accounts are contractually loss-absorbing, we have not seen cases of depositors bearing losses,” it noted.

Fitch also said that the need to comply with Shariah principles makes the banks’ transition away from the London Interbank Offered Rate (Libor) more complex as opposed to conventional products.

Legacy Islamic contracts will need to be individually renegotiated, but Islamic banks’ exposures to Libor are manageable, it added. — Bernama