Malaysian Banks Face Tighter Lending as Deposit War Squeezes Margins

Margin Pressure Intensifies

Malaysian banks are confronting sustained pressure on their net interest margins as the cost of funding rises, driven by fierce competition for deposits. The squeeze threatens to reshape the lending environment across Southeast Asia's third-largest economy.

Net interest margins across the sector narrowed by two basis points quarter-on-quarter and three basis points year-on-year during the second quarter of 2026, according to Hong Leong Investment Bank Research. The trend has prompted concerns that banks may become more selective in extending credit, potentially constraining economic growth.

Alliance Bank Malaysia recorded the highest margin among major lenders at 2.3 percent, down from 2.43 percent five quarters earlier. Affin Bank posted the lowest at 1.5 percent, followed by RHB Bank at 1.8 percent. Malayan Banking, Public Bank, CIMB Group Holdings and Bank Islam Malaysia each reported margins of 2.1 percent.

The Funding Squeeze

Banks are competing aggressively to attract deposits as loan demand remains robust, creating upward pressure on deposit rates. Tradeview Capital fund manager Neoh Jia Man noted that lenders are becoming increasingly selective in extending credit as margins narrow.

Bank Muamalat Malaysia chief economist Mohd Afzanizam Abdul Rashid explained that banks must maintain regulatory liquidity ratios, including liquidity coverage ratio and net stable funding ratio requirements. Institutions that manage their cost of funds efficiently can offer more competitive deposit rates, but the overall environment remains challenging.

The dynamic creates a potential feedback loop. If margins continue to compress, banks may need to raise lending rates, increasing financing costs for borrowers and ultimately pushing up business operating expenses and consumer prices.

Mixed Performance Across the Sector

The margin environment has produced divergent results across Malaysian banks. Alliance Bank, despite its relatively high margin, revised downward its full-year margin target to between 2.23 percent and 2.28 percent from a previous range of 2.28 percent to 2.35 percent. The bank reported first-quarter net profit of RM248.32 million, up 25 percent, even as revenue grew just 2.5 percent to RM630.93 million.

Alliance Bank management indicated that margins are approaching a floor, with the bank now prioritizing net interest income growth over margin expansion. The strategy involves rapidly growing a lower-yielding loan mix to drive absolute income rather than percentage spreads.

Affin Bank faces steeper challenges. Core net profit declined 11.13 percent year-on-year to RM127.52 million in the second quarter, weighed down by higher impairment allowances and reduced contributions from associates. Its margin compressed to 1.52 percent, though management attributed part of the weakness to delayed drawdown of a high-yielding loan.

CIMB Securities downgraded Affin Bank to Hold with a RM2.30 target price, citing concerns that the risk-reward profile has tilted negative following two consecutive quarters of elevated provisions. The firm noted that a re-rating requires clear evidence that credit costs have peaked and asset quality is stabilizing.

Loan Growth Dynamics

System-wide loans expanded 5.6 percent year-on-year in July 2026, up marginally from 5.5 percent in June, according to Bank Negara Malaysia. The non-household segment led growth, driven by electricity, gas, water, transport and communications sectors.

Small and medium enterprises accounted for much of the lending uptick during the quarter, alongside working capital, mortgages and corporate activities. Non-household loans grew 6.4 percent in July, well above the industry average, reflecting strong private-sector investment activity.

Household lending remained steady at 5.0 percent growth, signaling more cautious consumer sentiment. Digital financing platforms, including buy-now-pay-later services that offer interest-free periods, are emerging as direct competitors to traditional credit cards, potentially fragmenting household credit demand.

Malacca Securities head of research Loui Low noted that aggressive loan growth carries risks, primarily higher funding costs and potential asset-quality pressure. However, he assessed these risks as unlikely to materialize in the near term.

Outlook and Policy Implications

MBSB Research expects margin weakness to persist but believes steep compression is unlikely. Most banks do not anticipate significant margin recovery in coming quarters as long as deposit competition remains intense and loan demand stays elevated.

The research firm expressed greater confidence in the longer-term outlook, anticipating that accumulation of higher-yielding loans will eventually lift asset yields and support margins.

Mohd Afzanizam suggested that a 25-basis-point reduction in Bank Negara Malaysia's overnight policy rate next year could ease margin pressure. Without such relief, intense deposit competition will continue to challenge banks' pricing power and profitability.

The margin squeeze highlights a broader tension in Malaysia's financial system. Robust economic activity is driving loan demand, but the funding required to meet that demand is becoming more expensive. Banks that navigate this environment successfully will likely be those that balance growth ambitions with disciplined cost management and prudent risk controls.

For now, the sector faces a delicate balancing act between supporting economic expansion and maintaining the profitability necessary to absorb potential credit losses as lending books grow.