July 11 (Bloomberg) -- RHB Islamic Bank Bhd., a unit of Malaysia's fourth-largest banking group, expects financing for agriculture to drive growth in assets that comply with Muslim religious tenets, said Chief Executive Officer Khalid Bhaimia.

Assets at the bank may expand more than 10 percent this year, Bhaimia said in an interview in Kuala Lumpur on July 7. Financing for farming and small and medium-sized companies will grow more than 20 percent in 2006, he estimates.

Malaysia's government is encouraging agriculture under a 200 billion ringgit ($55 billion) development plan. Agriculture made up 8.2 percent of the economy last year in Malaysia, the world's largest exporter of palm oil and Southeast Asia's second largest oil and gas producer. It also produces timber, rubber and pepper.

``Islamic finance seems to be gaining a lot of pace in terms of new funds going into these sort of products,'' said Paul Teoh, who helps manage $272 million of Asian assets at Meridian Asset Management Sdn. in Kuala Lumpur, including Islamic bonds. Islamic finance in Malaysia is still ``in its infancy so definitely we are going to see huge potential there.''

Muslim investors may prefer to put money in commodities such as palm oil and rubber because Islamic law forbids interest payments and investment in businesses such as tobacco, alcohol and gaming.

Securing Market Share

``It's a growing sector, so there's a lot of potential for the bankers, not only for the Islamic banks,'' said Chan Ken Yew, a banking analyst at OSK Research Sdn. in Kuala Lumpur. ``Since Islamic banks have restrictions, this sector seems to be good for them and it makes sense for them to work even harder to secure market share.''

Financial services companies are introducing more Islamic products to tap the funds of 1.5 billion Muslims worldwide. The global Islamic finance industry's assets under management may have topped $1 trillion, according to a January report by the Malaysia-based International Islamic Financial Services Board.

In Malaysia, Islamic bank assets rose 18 percent to 112 billion ringgit last year, or 11 percent of the Southeast Asian country's total bank assets. About 60 percent of Malaysia's 27 million population is Muslim.

Under an Islamic financing concept called Murabahah, a bank may buy goods or land on behalf of a customer and sell them back at a higher price later to comply with the Islamic ban on the payment of interest. Such deals are common in short-term loans and trade finance. Commodity Murabahah involves mark-ups on asset prices in place of interest.

Plantation Companies

Malaysian plantation companies have been selling Islamic bonds to raise money for expansion. Dura Palms Sdn., a funding vehicle for plantation and investment company Teck Guan Holdings Sdn., sold 284 million ringgit of Islamic bonds in June. Boustead Holdings Bhd., a plantation and property group, raised 442 million ringgit from the sale of such securities.

Rising consumer spending in China and India is driving demand for commodities such as palm oil and rubber produced by Malaysia. Higher crude oil prices are also pushing up prices of natural rubber and alternative fuels such as palm oil.

Natural rubber futures traded in Tokyo, a benchmark for the commodity, have gained 41 percent since the year started to 289.3 yen ($2.54) a kilogram.

Palm oil futures traded in Malaysia have gained 6.8 percent since the year started to 1,511 ringgit a metric ton. For the year ended October 2005, palm oil imports into China rose to 4.36 million tons, more than double the 1.67 million a decade earlier, according to data from the U.S. Foreign Agricultural Service which tracks trade competing with U.S. produce.

Assets

RHB Islamic's assets expanded 23 percent to 7.6 billion ringgit last year, according to its 2005 annual report.

Financing for agriculture and small and medium companies makes up about 30 percent of RHB Islamic's financing portfolio, Bhaimia said. RHB Islamic also offers Bai Salam, or advance purchase financing, which allows the bank to finance a product to be delivered at a future date, he said.

Competition is increasing between Islamic banks in Malaysia, which has 12 such institutions, including Bank Islam Malaysia Bhd., the oldest, and Bank Muamalat Malaysia Bhd. The central bank has granted licenses to international banks, including Kuwait Finance House and Saudi Arabia's Al Rajhi Banking & Investment Corp.

``This is a very competitive market and it's a very crowded market, and therefore you've got to get a strong foothold in the niche,'' Bhaimia said.

Islamic banks in Malaysia may start merging over the next two years, he said, estimating about half the current number of such banks would be sufficient for a market the size of Malaysia.

RHB Islamic plans to expand outside Malaysia in the next five years to markets such as Vietnam, Indonesia, the Middle East and the Indian subcontinent, Bhaimia said.

RHB Capital Bhd. became the first commercial banking group to open a full-fledged Islamic financial services unit last year, transforming its Islamic banking window into RHB Islamic.

To contact the reporter on this story: Stephanie Phang in Kuala Lumpur at sphang@bloomberg.net

Last Updated: July 11, 2006 00:03 EDT