KUALA LUMPUR (May 9): Asia-Pacific Islamic banks can expect steady expansion and broadly stable asset quality for the next few years, at least, according to S&P Global Ratings.

In a report entitled Asia-Pacific is ripe for Islamic banking development, S&P Global Ratings credit analyst Nikita Anand said the agency expects financing growth to remain favourable for Islamic banks in the Asia-Pacific over the next few years.

"That's thanks to stable economic conditions in the core Islamic banking markets of Malaysia and Indonesia,” she said.

Anand said Malaysia will remain the biggest Islamic banking market in the Asia-Pacific, with about two-thirds of the sector's total assets of about US$400 billion (RM1.9 trillion).

But she said some large Islamic banks in the country could find it difficult to maintain their overall high growth if their retail deposit growth doesn't keep pace.

Anand said banks will have to diversify into other funding sources such as investment accounts or rely on wholesale deposits, which are generally more expensive.

"The launch of new Islamic banks in Malaysia and other Asia-Pacific markets this year could improve access to financial services for underserved regions and segments, such as small businesses," she said.

Anand said Indonesia is likely to be a growth hotspot, given its significant untapped potential.

She said Bangladesh also has potential, but a liquidity shortage and weak external demand there are likely to weigh on financing growth over the next one to two years.

"Risks for Asia-Pacific Islamic banks are tilted towards the downside, due to higher-for-longer rates and rising geopolitical tensions," said Anand.

Anand said small businesses and low-income households are vulnerable to sustained higher costs of living and rates.

“In such a scenario, we would expect both financing demand and asset quality to falter. Banks' ample capital and provisions provide a buffer against rising stress,” she said.