This article first appeared in The Edge Malaysia Weekly on August 2, 2021 - August 8, 2021

MALAYSIA’s two remaining standalone foreign Islamic banks, which have struggled to gain market share in the highly competitive Islamic banking industry for many years, made losses last year amid the Covid-19 pandemic.

Many in the industry question the ability of Kuwait Finance House (Malaysia) Bhd (KFHM) and Al Rajhi Banking & Investment Corporation (M) Bhd (ARBM) to survive over the long term and believe that merger and acquisition (M&A) options or an exit could be forthcoming.

Malaysia is a competitive market as there are 14 other Islamic banks in the country. According to S&P Global Ratings, the Islamic banks under the eight local banking groups alone accounted for more than 76% of the domestic Islamic financing market share as at end-2020, up from 67% in 2010.

This highlights how competitive the market is and how much harder it is for the smaller standalone banks like KFHM and ARBM to hold their own against the larger players who can leverage on business and funding synergies with their parent companies.

“Several standalone, foreign investor-backed Islamic banks [in Malaysia] are struggling to make profits and are saddled with high non-performing loans. Some foreign investors of those banks are already looking to exit Malaysia after years of underperformance,” S&P said in a July 5 report, without naming the banks.

It said M&A is likely if “small Islamic banks cannot find a way to turn around their operations in the tough competition with local banking giants”.

KFHM and ARBM, however, have given no such indication, with each telling The Edge that their respective Middle Eastern parent company continues to be strongly committed to the Malaysian operations.

KFHM, the larger of the two by asset size, has made losses for two straight years now. It posted a net loss of RM79.02 million in the year ended Dec 31, 2019 (FY2019), followed by a narrower loss of RM13.21 million in FY2020.

Last year’s loss was mainly because it booked in a modification loss of RM47.17 million arising from accounting standard requirements as a result of the automatic six-month loan repayment moratorium. According to its CEO Mohd Hazran Abd Hadi, KFHM recorded higher tax expenses in both FY2019 and FY2020 following the change in the national tax regime in 2018 in relation to certain matters. This is a non-cash item, he points out.

He expects the group to return to profit this year. “Positive financial results are expected this year, FY2021, as we have seen positive results in our ongoing initiatives as planned. As a subsidiary of the second-largest Islamic banking group in the world, KFHM continues to operate with a strong Islamic banking niche in accordance with international shariah standards, underpinned by solid funding with a healthy liquidity profile,” he tells The Edge in an emailed response to questions.

In 1Q2021, KFHM posted a net profit of RM8.62 million compared with RM13.35 million in the same period last year. Total assets stood at RM8.29 billion, while its Common Equity Tier 1 (CET-1) ratio, a key capital ratio, stood at 35.39%. KFHM is mainly a retail bank with a focus on home and personal financing.

Meanwhile, ARBM, which recently attempted to merge with Malaysian Industrial Development Finance Bhd (MIDF), slipped into a net loss of RM62.71 million in FY2020 from a net profit of RM29.31 million in FY2019. Allowance for credit losses on financial assets stood at RM27.28 million compared with a writeback of RM11.89 million in the previous year.

The loss in FY2020 was mainly because it booked in a modification loss of RM21.1 million. The group’s total assets have fallen over the years, to RM7.13 billion compared with RM7.58 billion in 2018.

In 1QFY2021, the group posted a net loss of RM12.36 million compared with a loss of about RM14 million in the same quarter a year earlier.

The bank, owned by Saudi Arabia-based Al Rajhi Bank, the world’s largest Islamic lender by assets, did not proceed with a merger with MIDF last year, despite months of negotiations. It is understood that the two could not resolve an impasse relating to the application of shariah rules in the merger. Adding to the complications was the Covid-19 pandemic.

This year, ARBM saw a slew of personnel and board changes. Since mid-February, there has been a new CEO — Arsalaan Ahmed, the former CEO of HSBC Amanah Bhd — as well as a management and board revamp. The industry is waiting to see if the new leadership is able to turn the bank around in a sustainable manner. Its previous CEO, Steve Chen, left to pursue other interests.

In recent press releases, the bank stated its aim to become the “No 1 foreign Islamic bank” and an “award-winning” Islamic bank in Malaysia. Critics consider its objectives a tall order for now given its financial position.

“With challenges come opportunities, and we at ARBM believe that during these tough times, there exists an opportunity to chart a new future based on what will undoubtedly be the new normal,” Arsalaan tells The Edge in an emailed response.

Without going into details of the bank’s strategy, he says the bank will continue to focus on corporate, small and medium enterprises (SME) and retail banking.

“Corporate remains an important franchise for ARBM and we look to grow that while raising our SME and retail offerings to a similar level of leadership. As we embark on a comprehensive digital transformation to boost our overall service delivery, our customers can expect enhanced Islamic propositions and banking experience. We will also continue to build on our unique position in pilgrimage-related offerings, as well as our unparalleled access to the Malaysia and Kingdom of Saudi Arabia corridor,” he says.

Asked whether he expects the bank to return to the black this year, Arsalaan says: “While 2021 is challenging as well, the bank continues to aim to create profits by working with our customers to navigate the year together. The bank’s capital position remains robust. We have also made the necessary strategic investments, particularly in strengthening our people and our digital capabilities, to benefit our customers. We are committed to Malaysia and the investments are a testament to our commitment. In short, we aim to grow the business and we are not looking back.”

Its CET-1 ratio stood at 11.52% as at March 31, while total assets fell further to RM6.89 billion. Corporate financing accounted for the bulk or 71% of its total financing of RM5.04 billion.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.