Malaysia Banking Sector Set to Outperform in 2026: Defensive Shelter with Cyclical Upside

Overview: Banking Sector Upgraded to Overweight Amid Favorable Macro Trends

UOB Kay Hian has upgraded Malaysia’s banking sector to OVERWEIGHT status, positioning it as a prime beneficiary of a soft landing in the US and a rotation into emerging markets. Despite US tariff uncertainties, the sector’s resilient earnings, attractive dividends, and defensive characteristics make it a compelling choice for investors seeking shelter and upside in an evolving macro environment. Malaysian banks offer robust liquidity, solid provision buffers, and dividend yields around 5%, setting the stage for sector outperformance in the early phase of a cyclical recovery.

Global Macro Tailwinds: US Tariffs, Inflation, and Fed Rate Cuts

• US Inflation: July 2025 CPI data showed core inflation at 3.1%, only slightly above April’s 2.8%, with headline CPI at 2.7%—less than feared given the tariff environment.
• Tariff Impact: Businesses are mitigating tariff effects by using pre-tariff inventories and absorbing costs, limiting inflationary pressures. Goods only comprise 25% of CPI and PCE, while services (75%) remain less impacted.
• Fed Rate Cuts: The US labor market is cooling, with lower-than-expected non-farm payroll gains, increasing the odds of rate cuts. Futures price a 92% chance of at least one cut in September and 60% for a second by year-end 2025.

Emerging Market Flows: Malaysian Banks Well-Positioned

As the Fed Funds Rate–Overnight Policy Rate (OPR) spread narrows and macro growth remains resilient, Malaysia is set to attract increased emerging market inflows. The sector’s year-to-date (YTD) underperformance relative to the KLCI and slowing foreign shareholding decline in Q2 2025 suggest that value is emerging. The sector is poised for re-rating, especially as investors look beyond 2025 OPR cuts towards a Net Interest Margin (NIM) recovery in 2026.

Key Sector Catalysts: NIM Recovery, Asset Quality, and Non-Interest Income

• NIM Recovery: With markets likely pricing in all potential OPR cuts in 2H25, a cyclical bottom is expected in 2025, paving the way for NIM recovery in 2026.
• Valuations: December FYE banks now valued on a 2026 basis, with non-December FYE banks already pegged to FY26.
• Foreign Bond Flows: Net buying of domestic government bonds has driven the 10-year MGS yield to 3.37% (from 3.68% YTD), below the pre-pandemic average despite unchanged OPR.
• Asset Quality: Sector GIL ratio improved to 1.42% in June 2025, versus pre-COVID averages of 1.5%-1.7%. Mortgages now comprise 36% of loan portfolios (up from 30%), reflecting structural de-risking.
• Provision Buffers: Higher Loan Loss Coverage (LLC) ratios—90% vs pre-pandemic 80%—support stable credit costs, with a flattish sector net credit cost assumption of 18bps for 2025.
• Non-Interest Income: Strong foreign inflows have boosted trading gains and FVOCI reserves by 20-30% to a five-year high. US dollar weakness supports forex hedging fees, while wealth management income is set to recover in 2026.
• Earnings Growth: Sector earnings expected to grow 4% in 2025 and 6% in 2026, underpinned by 5% loan growth, stable credit costs, manageable NIM pressure, and non-interest income upside.

Top Sector Picks: Comprehensive Company Analysis and Target Prices

CIMB Group: Upgraded to BUY – Value Emerges Despite YTD Sell-Down

• Share price down 10% YTD, lagging KLFIN Index’s 3% decline.
• Valuations compressed to 1.0x 2026 PBV, below sector average, despite higher ROE (11% vs sector 10%).
• Sell-down driven by tight liquidity in Indonesia, pressuring CIMB Niaga’s NIMs, but conditions are easing as Fed rate cuts resume.
• Potential catalysts: Recovery in Indonesia NIM, stronger non-interest income from trading gains.

Public Bank: Defensive Play with Strong Asset Quality

• Trading at -1SD below historical mean PBV.
• Robust provision buffers offer greater write-back potential.
• Stable earnings trajectory underpinned by strong asset quality and mortgage portfolio growth.

Hong Leong Bank: Solid Fundamentals

• Consistent performance, trading at -1SD below historical PBV mean.
• High provision buffers and stable asset quality support resilience.
• Attractive risk/reward profile for investors seeking quality.

RHB Bank: High-Beta Upside

• Included as a high-beta pick for risk-on investors.
• Attractive valuation and strong dividend yield (7.4%).
• Solid provision buffers and stable credit cost outlook.

AMMB: Trading Gains and Dividend Appeal

• High-beta sector pick with strong trading gain upside.
• Dividend yield of 6.7% and robust provision buffers.
• Potential for non-interest income surprise as foreign inflows strengthen.

Other Banks: Sector Performance Highlights

• Maybank: HOLD rating; moderate earnings growth, sector-leading market cap, dividend yield 7.0%.
• Alliance Bank: HOLD; solid fundamentals, dividend yield 5.0%.
• Affin Bank: HOLD; underperformed with 13.4% YTD decline, lowest dividend yield in the sector (2.7%).
• Bank Islam: HOLD; significant YTD decline, dividend yield 5.8%.
• HLFG: BUY; strong ROE, attractive valuation, and solid dividend yield (3.2%).

Sector Outlook: Defensive Shelter with Cyclical Upside

• Malaysian banks offer defensive earnings and attractive dividend yields, with the potential to outperform as a risk-on environment emerges.
• Foreign bond flows are likely to spill over into equities, reinforcing sector rotation appeal.
• Asset quality remains robust, with GIL ratios near historical lows and higher LLC ratios supporting stable credit costs.
• Non-interest income is set for upside surprise, supported by trading gains and FX/wealth management recovery.
• Steady earnings growth expected in 2025/26, driven by NIM recovery, loan growth, and resilient asset quality.

Conclusion: Malaysian Banks Poised for Rotation and Re-Rating

With resilient fundamentals, attractive yields, and early signs of cyclical recovery, Malaysia’s banking sector stands out as a prime candidate for defensive allocation and growth. The sector’s robust asset quality, provision buffers, and potential for non-interest income upside create a compelling case for investors seeking value and performance in 2026 and beyond.