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Conventional and Islamic Loans in Malaysia: A Comparative Analysis in the Light of 2023 Developments

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Understand the differences between Conventional and Islamic loans in Malaysia. Learn about their principles, the impact of the 2023 Standardised Base Rate update, and stay informed about Malaysia's banking landscape.

In the dynamic world of finance, understanding the nuances of different loan systems is crucial, especially in a diverse financial market like Malaysia. With a myriad of loan options available, conventional and Islamic loans stand out due to their unique principles and growing relevance. Particularly in light of the recent changes in the Malaysian financial landscape in 2023, these two types of loans have become a focal point of discussion.

Overview of Conventional and Islamic Loans

Conventional loans, the more common type globally, operate on the principle of a borrower-lender agreement. The bank, or the lender, provides the borrower with a certain sum of money, which is then repaid with interest over a specified period. This interest, often tied to the Base Lending Rate (BLR), forms the primary cost of the loan for the borrower.

Conversely, Islamic loans follow the principle of profit-and-loss sharing, rooted in the tenets of Islamic law, or Shariah. This system prohibits 'Riba' (interest), leading Islamic banks to devise a unique approach to lending. Instead of providing a loan and charging interest, Islamic banks purchase an asset and sell it back to the borrower at a marked-up price, which is then repaid in instalments. The Base Financing Rate (BFR) often serves as the reference rate in Islamic finance.
 

Key Differences between Conventional and Islamic Loans

 Conventional LoansIslamic Loans
BasisBased on the principle of lending money and earning interest.Operate on 'Murabahah', a cost-plus-profit approach.
Income GenerationThe bank's primary income source is the interest charged on the principal amount lent.The bank's profit comes from selling an asset to the customer at a price higher than its cost.
Interest/ Profit Rate CappingThe interest for conventional loans is tied to the Base Rate, which can be modified in response to current market conditions without any upper limit. If there is an increase in the interest rate, customers will need to adjust by paying a higher installment amount to cover the rise in lending costs. The ceiling profit rate in Islamic loans is the maximum rate chargeable under sale-based financing. It's tied to the Islamic Base Rate (BFR), adjustable with market conditions but never exceeding the ceiling rate.
Risk SharingAll the risk of the loan is transferred to the borrower.Emphasizes risk-sharing between the lender and borrower. In the event of a default, losses are shared according to pre-agreed terms.
Ethical ConsiderationsNo specific ethical or moral guidelines restrict the activities financed by the loan.Guided by Shariah law, which prohibits financing certain activities deemed harmful to society.
Late RepaymentsSince profit is determined solely by the outstanding principal, late repayments ought to result in reduced penalties.Due to interest being calculated on a compounding scale, late repayments may result in relatively higher penalties.
Early SettlementIf you choose to settle early, you may face a substantial exit penalty due to the lock-in period.You have the option to terminate the contract without facing any penalties, provided that you fulfill your outstanding obligations in a fair manner.

 

The Changing Landscape - SBR, BLR, and BFR

In Malaysia, if you're taking out a loan, particularly a housing loan, you'll likely come across terms like Base Rate (BR), Base Lending Rate (BLR), and Base Financing Rate (BFR). As of 9th May 2023, the Standardised Base Rate (SBR) is 3.00% per annum, the Base Rate (BR) is 4.00% per annum, and the Base Lending Rate (BLR) or Base Financing Rate (BFR) is 6.85% per annum​ according to CIMB. To help you understand these concepts better, this blog post will explain what these terms mean, how they are determined, and how they affect you as a borrower.

What is Base Rate (BR)?

The BR in Malaysia was introduced in 2015 as a new reference rate framework. It replaced the Base Lending Rate (BLR) as the main reference rate for new retail floating rate loans. The BR is more transparent and provides a more reflective measure of a bank's cost of funds. It is linked to the KLIBOR and is determined by the individual bank's benchmark cost of funds and statutory reserve requirement (SRR).

What is Base Lending Rate (BLR) or Base Financing Rate (BFR)?

The BLR or BFR is the minimum interest rate at which commercial banks are willing to lend out their money. It is used as the reference rate for retail loans, especially home loans. Prior to the introduction of the BR, the BLR was used as the reference rate for retail floating rate loans.

What is the Standardised Base Rate (SBR)?

Starting from 1st August 2022, Bank Negara Malaysia (BNM) replaced the BR with the Standardised Base Rate (SBR) following the revised Reference Rate Framework. The SBR is now in tandem with the Overnight Policy Rate (OPR).

How are SBR, BLR/BFR, and SBR determined?

The SBR is based on a bank's benchmark cost of funds and the Statutory Reserve Requirement (SRR). The BLR/BFR is determined by banks without interference from the Central Bank. Banks can choose to increase or decrease their BLR/BFR in response to market conditions. The SBR, introduced in August 2022, follows the OPR as determined by BNM.

In the previous reference rate system, each bank has the flexibility to establish its own Base Rate (BR), meaning that BR varies from bank to bank. But with the implementation of the new framework, all banks will align to a single rate known as the Standardized Base Rate (SBR). This implies that the SBR will be identical across all banks.

Source: Bank Negara Malaysia (BNM)

The Base Lending Rate (BLR), the main reference rate for conventional loans, and the Base Financing Rate (BFR), its Islamic finance counterpart, are impacted by these changes. As of May 2023, the SBR for conventional and Islamic loans stands at 3.00%, while the BLR is 4.00%, and the BFR is 6.85%.

The shift towards the SBR system is expected to improve transparency in loan pricing and make it easier for borrowers to make informed decisions. Given the distinct principles of conventional and Islamic loans, it will be fascinating to see how this change impacts both financial sectors.

The trends of Median BLR/BFR,Median BRandMedian SBR for Date Year. Colour shows details about Median BLR/BFR,Median BRandMedian SBR.

Source: https://www.cimb.com.my/en/personal/help-support/rates-charges/cimb-base-rate-base-lending-rates.html

The figure above reveals a noticeable downtrend in interest rates since 2015, a trend with multiple implications for an economy, including Malaysia's. These implications may encompass promoting borrowing and investment, stimulating consumer spending, reducing savings, depreciating the currency, reviving the housing market, and escalating the risk of inflation. In the context of Malaysia, a country renowned for its dynamic and diversified economy, these effects could manifest in several unique ways.

For instance, Malaysia has a robust export sector, especially in electronics, oil and gas, palm oil, and rubber. The potential currency depreciation resulting from lower interest rates could boost the competitiveness of its exports in the global market. On the flip side, as Malaysia relies heavily on imports, a weaker currency could inflate import costs.

However, it's essential to remember that the actual impact of lower interest rates depends on multiple variables, such as the economic state, the levels of consumer and business confidence, global economic conditions, and the government's monetary and fiscal policies.

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The Future of Conventional and Islamic Loans in Malaysia

With the introduction of the SBR and the continued growth of the Islamic finance sector, the future of lending in Malaysia looks promising. Conventional loans, with their familiar and established systems, will continue to serve a significant portion of borrowers. However, the Islamic finance sector is catching up fast, supported by government initiatives, digital innovation, and an increasing awareness and demand among consumers.

The government’s ‘Islamic First’ strategy and the establishment of the Value-Based Intermediation (VBI) framework have resulted in significant growth in the Islamic finance sector. The digital banking licences awarded to Islamic finance institutions and the plans to develop the Halal economy, as outlined in the Halal Industry Master Plan 2030 and the Financial Sector Blueprint, further drive this growth.

According to the study done by Liza Marwati Mohd Yusoff, Aisyah Abdul Rahman, and  Norazlan Alias (2021) on ‘Interest Rate and Loan Supply: Islamic Versus Conventional Banking System’, the finding indicated both Islamic and conventional loan growth of merchant banks are significantly positive associated to the growth of overnight Kilbor, while Islamic loan growth of merchant banks is more sensitive to changes in overnight Kilbor growth.

As both sectors continue to evolve, they will offer a wide range of financial solutions catering to the varied needs of the population. It's an exciting time for the financial industry in Malaysia, with the opportunity for both conventional and Islamic finance to grow and thrive.

 

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Conclusion

This concludes our exploration of conventional and Islamic loans in Malaysia. The landscape is continually evolving, with both sectors making significant strides in their growth and development. As we look to the future, it's clear that Malaysia's financial sector will continue to be a dynamic and exciting space, offering a diverse range of financial solutions to its population. As borrowers, it's essential to stay informed about these changes and developments, ensuring we can make the best financial decisions for our circumstances.

The journey of understanding and navigating the world of finance may seem daunting, but with the right knowledge and guidance, it can become an empowering experience. Here's to a financially literate and empowered Malaysia!

 

 


 

Category: Loan