The Malaysian banking sector is expected to experience modest growth in the near term, constrained by rising funding costs and potential market pressures related to the recent expansion of the Kuala Lumpur Composite Index (KLCI), according to a transactional research report released following July’s banking data.
Despite steady loan growth and improving momentum in business lending, the sector’s outlook remains cautious, with limited catalysts to drive a significant re-rating. Business lending continues to provide the primary impetus for growth, supported by a sharp year-on-year increase in loan applications and approvals. In July, business loan applications rose 37.7% compared to the same month last year, while approvals surged 51.9%, surpassing June’s levels of 45.9% and 35.3% respectively. Correspondingly, the business loan approval rate improved from 60.8% in June to 65.2% in July.
The manufacturing and services sectors have been key contributors to this uptick, with business loans growing by 7.5% on a yearly basis, slightly up from 7.3% in June. Overall system loan growth held steady at 5.6%, while household lending remained relatively flat at 5%. Household loan demand appeared subdued, reflected in a mere 1.7% year-on-year increase in applications and a 2.6% decline in approvals. Loan disbursement growth, however, strengthened to 7.6%, while repayments moderated to 6%.
On the funding side, deposit growth moderated to 5.6% year-on-year in July from 6% in June. Growth in current accounts and savings accounts (CASA) also eased to 7.1% from 7.7%. Nonetheless, CASA deposits continued to outpace overall deposit growth, and fixed deposits remained broadly stable, indicating a favorable funding mix for banks.
Asset quality stayed resilient, with the system’s gross impaired loan (GIL) ratio unchanged at 1.43% for the third consecutive month. Household GIL saw a modest improvement to 1.10%, while business GIL remained steady at 1.91%, with no indications of emerging stress despite the stronger credit expansion in the business segment.
However, rising funding costs have started to compress lending spreads. The lending spread narrowed by three basis points month-on-month to 2.36%, influenced by a faster rise in three-month fixed deposit rates relative to average lending rates. Still, the spread remains slightly above May’s level by four basis points, suggesting that margin conditions have not deteriorated significantly.
Among individual banks, Alliance Bank Malaysia Bhd was recommended as a top pick for the second half of the 2026 financial year given its resilient earnings prospects and its potential inclusion in the expanded KLCI. Other banks rated as “buy” included AMMB Holdings Bhd, CIMB Group Holdings Bhd, and RHB Bank Bhd, while Affin Bank Bhd, BIMB Bank Islam Malaysia Bhd, Malayan Banking Bhd, and Public Bank Bhd received “hold” ratings.
An analyst expressed concerns not about loan growth, which is projected at 5% to 5.5% for 2026, but rather about weakening underlying credit metrics. Sector and system loan-loss coverage ratios have declined by 16 and 11 percentage points respectively since the end of 2024, raising the possibility that banks may have reduced buffers to absorb future credit costs. Funding pressures were also highlighted, as higher wholesale deposit rates compel banks to compete more aggressively for retail deposits amid robust loan pipelines and elevated loan-to-deposit ratios, potentially intensifying cost pressures going forward.