Malaysia leads the way for Islamic finance

Based on the results of this year’s Top Islamic Financial Institutions ranking, the sharia-compliant financial industry enjoyed a successful 2013. Growth and expansion across a number of key data indicators went hand in hand with an increase in the quality of the industry’s development. This performance is reflected by upswings along key data indicators in this year’s report, including total sharia-compliant assets, which increased by 9.81% year on year. However, the data from this year confirms that, while growth is still positive, it is likely to remain at a slower-than-usual pace over the coming years. The global compound annual growth rate (CAGR) for the industry reduced marginally to 15.73% from 16.02% last year.

Moreover, the positives to be drawn from this bigger picture mask a number of challenges faced in specific markets as Islamic banks’ margins continue to be squeezed by a lower growth global environment and greater competition. It should be noted that these relatively slower performances were predominantly reserved for smaller and less developed sharia-compliant markets. In terms of the larger, higher growth jurisdictions, including Malaysia and the Gulf countries, 2013 was another strong year.

GCC domination

In particular, the industry’s global success was evident in the growth of sharia-compliant assets. Year-on-year increases were recorded in the Middle East and north Africa (excluding the countries of the Gulf Co-operation Council) with 9.67%; as well as Asia (4.38%); Australia, Europe and America (8.43%); and sub-Saharan Africa (1.88%). Yet, it was the countries of the Gulf Co-operation Council that dominate this year’s report, registering an 11.6% increase in sharia-compliant assets year on year.

The impressive performance of the region’s Islamic banks accounts for much of this gain. In particular, lenders from Saudi Arabia, Bahrain, Qatar and the United Arab Emirates once again emerged as the big winners. Qatar’s CAGR jumped from 19.56% to 22.84% in this year’s report, while Saudi Arabia’s increased from 14.32% to 16.87%. Meanwhile, institutions in the UAE enjoyed a standout year as CAGR increased from 6.22% to 11.19%.

On the whole, the picture for the aggregate return on average assets (ROAA) also improved in this year’s report, rising to 1.68% from 1.43% last year. This was largely driven by gains from Bahrain, which increased from 0.18% to 0.41%, the UAE, registering an increase from 1.39% to 1.43% and Malaysia, which jumped from 1.73% to 1.80%.

Profitability dent

However, as was the case last year, the significant rate of asset growth has not been matched by a corresponding uptick in profitability in some markets. Saudi Arabia maintained its downward trajectory with aggregate ROAA declining further from 2.65% last year, to 2.54% this year.

Similarly, Qatar fell from 2.58% to 2.42%. While the rate of asset expansion in these markets, which exceeded most regional competitors excluding the UAE, accounts for this to some extent, it does not provide a full picture. Other dynamics, including tougher competition from conventional peers, as well as a contraction in net interest margins across the Islamic banking sector, are also to blame, according to rating agency Standard & Poor’s.

In Saudi Arabia, only one lender, Al Rajhi Bank, achieved a higher ROAA than the national aggregate, with 2.72%. Yet, the bank’s profitability suffered in 2013, down 5.66% from the previous year. Beyond this, only the Saudi British Bank, National Commercial Bank, Bank Albilad and Saudi Hollandi Bank saw return on assets above 2%. The remaining Saudi-listed institutions achieved ROAA of between 0.36% and 1.84%.

As noted by EY, the Saudi banking sector is awash with liquidity, driving up competition for corporate credit and placing additional pressure on banks’ margins. However, these figures need to be analysed in a broader context. ROAA for the sector as a whole in Saudi Arabia, including both conventional and Islamic institutions, was 2.02% in 2013, according to The Banker Database. As such, Islamic lenders’ incremental decline in ROAA should be seen as part of a gradual convergence with conventional peers in what is a rapidly maturing market.

Iran on the up

Meanwhile, Iranian lenders, have on the face of it, performed considerably well given the difficult global environment in which they operate. Five of the top 10 commercial banks ranked by ROAA hailed from Iran, as they maintained their leading role in this ranking. Aggregate ROAA for the country improved from 1.22% to 1.43% this year, while the country’s CAGR surpassed the global average of 15.87% to hit 17.83%. This performance was backed by the strength of a number of leading institutions.

Iran’s Bank Pasargad recorded the highest ROAA of any Islamic lender, with 5.34%. The bank’s pre-tax profits also grew by 43.02% year on year, while its asset base jumped by 26.85%. Similarly, Karafarin Bank saw its ROAA hit 4.86%, while its asset base grew by 28.07%. Nevertheless, despite the apparent strength of these numbers, serious concerns over the strength of Iran’s lenders remain. Notably, most Iranian banks are significantly under-capitalised in relation to regional norms. Moreover, non-performing loans for the sector remain high.

In Asia, the key growth story emerged from Malaysia, the world’s leading centre for Islamic finance. The country witnessed steady growth both in terms of assets and profitability. Aggregate ROAA hit 1.80%, up from 1.73% in the previous year. Seven lenders from the country recorded ROAA above the global average of 1.68%, starting from the Development Bank of Malaysia’s 1.69% to Citibank Berhad’s country chart-topping 2.76%. The remaining 14 lenders posted gains of between 0.25% and 1.66%, pointing to a steady growth trajectory for the country as a whole.

This is all the more impressive given the year-on-year change in asset growth, with all but two Malaysian lenders registering increases in sharia-compliant assets. The assets of 11 Malaysian lenders surpassed the global average, rising by 10% or more year on year. In addition, the future looks bright for Malaysia’s Islamic banks as the government has set a target for the proportion of Islamic financing as a percentage of the country’s total to reach 40% by 2020. At present, it accounts for roughly 24%, according to research by Moody’s.

Foreign focus

In terms of foreign-owned subsidiaries, Al Baraka Group’s Syrian subsidiary had the highest ROAA at 5.11%. This startling performance came down to the subsidiary’s focus on treasury operations and the provision of indirect facilities, including letters of credit and guarantees, to balance against the challenge posed by a lack of high-quality local financing opportunities. However, the collapse in the value of the Syrian pound meant that the banks’ total assets fell by 23% to $424m in terms of US dollars, partly contributing to the upsurge in ROAA. Nevertheless, net profit reached $20m for the year, pointing to a strong performance under particularly difficult circumstances.

Elsewhere, the strength of the Turkish banking market was demonstrated through the presence of three foreign-owned subsidiaries in the market – Al Barakah Türk, Bahrain’s Al Baraka Group’s Turkish subsidiary, Kuvyet Türk, owned by Kuwait Finance House, and Türkiye Finans, the subsidiary of Saudi Arabia’s National Commercial Bank.

Building on last year’s rankings, Turkey has proven to be an attractive market for Gulf-based investment for both Islamic and conventional lenders. Eyeing the strong returns posted by their Islamic counterparts, a number of conventional lenders, including the Commercial Bank of Qatar and Lebanon’s Bank Audi, have recently made significant acquisitions in the market.

Finally, the presence of two foreign-owned subsidiaries operating in Indonesia points to the substantial growth prospects presented by the world’s most populous Muslim country. Indonesia’s ROAA reached 1.76% in 2013, up from 1.6% in the previous year. The new entry this year is Bank Niaga, owned by Malaysia’s CIMB group. This is the second Malaysian-owned subsidiary to enter the rankings, joining Maybank Indonesia Syariah. This comes as Malaysia’s Islamic lenders focus their attention on larger, higher growth markets in an effort to diversify away from their competitive home market.