AS MALAYSIAN ISLAMIC BANKS EXPAND EITHER DOMESTICALLY OR ACROSS BORDERS, THE NEED TO OBTAIN A RATING GROWS AS AN INCREASING NUMBER COUNTERPARTIES WILL NEED TO UNDERSTAND THEIR CREDITWORTHINESS AND FUNDAMENTALS.
The Malaysian Islamic banking industry’s assets have almost doubled in the last four years, standing at RM479 billion as at end-December 2014 (end- December 2010: RM254 billion) and accounting for 22% of the domestic banking system’s assets. RAM Ratings expects Malaysia’s GDP growth to ease slightly to 5.3% this year. Islamic banking financing growth will therefore moderate in 2015, but is still expected to stay robust at 15% (2014: 18%) compared to the overall Malaysian banking industry’s 7% loan growth, set against macroprudential measures to rein in household debt and the more challenging economic environment. The industry’s low gross impaired-financing (GIF) ratio of 1.2% as at end-December 2014, though aided by rapid growth in recent years, still marks a healthy checkpoint. Given the expectations of slower financing and economic growth, the Islamic banking system’s GIF ratio is likely to edge up but remain manageable below 2%. Malaysia’s Islamic banking sector has a relatively sturdy capitalisation, as reflected by its common-equity tier-1 capital ratio of 11.4% as at end-December 2014. Another point of strength for the sector is that most Islamic banks in Malaysia operate as part of a universal-banking model, which allows them to benefit from their parents’ branding and network as well as derive capital and funding support.
THE MAJORITY OF ISLAMIC BANKS IN MALAYSIA ARE RATED
Banks typically seek out ratings to satisfy the needs of counterparties and institutional depositors or if they plan to issue bonds or Sukuk. Institutional or corporate depositors could place limits on quantum of deposits depending on the rating of a bank as part of their own risk management, likewise among banks in the interbank
market. Obtaining a rating also allows a bank to set itself apart from its peers in the market place and provides all stakeholders with an independent perspective on a bank’s fundamentals – particularly its creditworthiness. Banks are confidence sensitive entities, and banks that choose to obtain ratings are typically viewed favourably by the market place. Higher rated banks tend to benefit from the ‘flight to quality’ phenomenon particularly during periods of either global or domestic economic stress periods, as depositors look for financial institutions that are viewed stronger. Therefore many of the commercial, investment and development banks in Malaysia as well as their bank holding companies are rated. This is true for Islamic banks as well – 61% or 11 out of the 18 Islamic banks in Malaysia are rated; out of which 4 are rated by more than 1 credit rating agency. The majority of the rated Islamic banks (see Table 1) in Malaysia are either part of domestic universal banking groups or locally incorporated foreign banks, whose parent banks’ are also rated. The very nature of the dual banking environment in Malaysia where Islamic banks operate in parallel with conventional counterparts, nudges many Islamic banks to obtain ratings to satisfy market and stakeholder needs.
KEY ELEMENTS TO RATING ISLAMIC BANKS
RAM Ratings considers the requirement for an Islamic bank to adhere to Shari’a principles. It is therefore vital to assess the business model employed and jurisdictional nuances, in order to apply our bank rating analytical framework to assess an Islamic bank’s credit fundamentals appropriately. RAM Ratings takes the stance that it is neither the role nor responsibility of a credit-rating agency to assess Shari’a compliance, as this is best done by the relevant experts. This is akin to how a rating agency also relies on audited financial statements prepared by accounting firms. In the context of analysing an Islamic bank’s risk-management culture and policies, our assessment also includes understanding an Islamic bank’s Shari’a approval process for its products and services.
THE FINANCIAL INSTITUTION ratings assigned by RAM Ratings to Islamic banks in Malaysia reflect the institution’s fundamental credit strength. In essence, the standalone credit strength of an Islamic bank will be first examined by looking into its capitalisation, asset quality, funding and liquidity positions as well as earnings. We will then also analyse systemic importance and consider support from the parent bank or shareholder, as the situation could require, before arriving at the assigned
rating. Many of the Islamic banks in Malaysia rated by RAM Ratings (see Table 2) have ‘AAA’ or ‘AA’ ratings on the Malaysian national scale primarily as a result of systemic importance or support factors. Islamic banks that are part of universal banking groups in Malaysia typically share the same rating as their parent bank or banking group after also considering the highly integrated nature of their franchise, operations and risk management. In the process of rating an Islamic bank, some other areas that are also looked at include (though this is not an exhaustive list):
• Shari’a compliance and the impact on reputational risk.
Any breach or negative perception on an Islamic bank’s Shari’a compliance potentially could result in regulatory penalties or a liquidity run on the Islamic bank as depositors react to such news or rumours. Given that Shari’a opinions could vary according to jurisdictions, the reputational risk of non-compliance on certain products and/or services in a particular jurisdiction could affect the perceptions of an Islamic bank’s depositors or counterparties – in either its home or foreign markets.
• Liquidity and funding in a dual banking market.
If most of the deposits in the system are within the conventional banking space, how an Islamic bank sources for deposits from corporates, individuals and the Islamic
inter-bank market (if available) is critical. Shareholder, regulatory or supranational support could feature as a key consideration in some instances.
• Market risk management.
Islamic banks may not have access to the full array of hedging instruments to manage market-related risks – which are available to their conventional counterparts. Under these circumstances, analyses on other modes used by Islamic banks to mitigate market risks will be done.
• Asset characteristics.
Apart from financing, Islamic banks could have the ability to invest in various assets, either directly (on balance sheet) or indirectly (through funds or related entities), e.g. property for investment purposes as well private equity. It is critical to understand the Islamic bank’s investment criteria, time horizon, decision-making process, portfolio management techniques and monitoring processes on these investment portfolios. RAM Ratings also gauges an Islamic bank’s risk appetite and the proportion of such assets that, in its opinion, are viewed to be risky as a proportion of its total assets. To assess its ability to withstand the volatility inherent in different classes of assets, we also examine the capitalisation and liquidity of an Islamic bank in relation to this.
ISLAMIC BANKING IN MALAYSIA ON A GROWTH TRAJECTORY
The development of the Investment Account Platform (“IAP”) mooted by the government and championed by Bank Negara Malaysia will spur innovation. IAP which could be viewed as a form of crowd funding intermediated by Islamic banks offers a new direction of growth for the Islamic banking industry in Malaysia. The IAP has
the potential to offer new investment avenues that can cater to a wider range of investor risk-return preferences targeting the financing of entrepreneurship in the real
economy. THE VISION TO CREATE a mega Islamic bank is also still on the cards, making this an exciting time for Islamic banking. As Malaysian Islamic banks expand either domestically or across borders, the need to obtain a rating grows as an increasing number counterparties will need to understand their creditworthiness and fundamentals.