The government originally aimed for 20 percent market share for Islamic banks by 2010, but despite double-digit growth in both lending and assets, the sector has fallen shy of this mark.
Their share of loan business crossed the 20 percent mark in January 2012, reaching 21.3 percent last December.
Malaysia now aims for an even more ambitious target - a 40 percent share of Islamic domestic financing by the year 2020 - and intends to make the industry more international, according to the country's master plan for capital markets development.
To achieve this, regulators have introduced new rules over the last two years and are preparing to release a brand-new legal framework for Islamic finance this year.
But private-sector banks need initiatives of their own, including steps to address a leadership vacuum and to strengthen their overseas strategies, says Ashar Nazim, Islamic financial services leader at consultants Ernst & Young.
"In the absence of these initiatives, these numbers are very ambitious - 40 percent is very difficult from population dynamics alone," he said.
Malaysia's proactive Islamic finance policies have made it a global model, but regulators have refrained from directing the strategy of Islamic banks.
"The market has to be demand-driven. We can put the enabling environment, but we can't require banks to offer products and services," central bank governor Zeti Akhtar Aziz said during a September media conference.
That makes the issue of who decides banks' strategy important, and critics believe bank boards often fail to give direction.
"Board composition is very vanilla, very ordinary. The quality of boards is under heavy criticism, that is where the struggle is," Nazim said.
Few of Malaysia's Islamic lenders have ventured overseas and only a handful have a significant regional presence. Some have established presences in Indonesia, but the vast bulk of their revenues remain domestic.
CIMB Islamic, the Islamic arm of CIMB, derives around 10 percent of its earnings from business in Indonesia, Singapore and Brunei, according to the bank.
"I don't think we'll see a significant shift...but we are really endeavouring for our business overseas to contribute more than the 10 percent," said Badlisyah Abdul Ghani, chief executive of CIMB Islamic.
"There is no point in setting up business in a new market if we can't be competitive; there are certain parameters that need to be in place before we can operate effectively. Government support is the main criterion."
Beyond Indonesia, Islamic banks see little chance for expansion of the industry in Asia; although China has a large Muslim population, there are major regulatory obstacles and a lack of infrastructure in the country's Muslim areas.
That leaves the Middle East, but for many Malaysian banks, that is seen as a step too far. With the exception of a few representative offices, no Malaysian bank has ventured into the Middle East.
"There are small markets in the Middle East such as Bahrain, Qatar and Oman, but these are city states and they are already well-banked," said Rafe Haneef, chief executive of HSBC Amanah Malaysia.
Maybank Islamic, the Islamic arm of Malayan Banking, has said expansion plans will focus on southeast Asia, with further plans for China, London and the Middle East. Its Indonesian unit was converted into a full-fledged Islamic bank in 2010.
At home in Malaysia, Islamic banks' expansion is hampered by their structure, analysts believe: they are mostly subsidiaries of conventional banking groups and leverage the branch networks of their parents to reach out to customers.
For instance, Public Islamic Bank distributes its products through the 248 branches of its parent, Public Bank, the country's third largest lender. Bank Islam, the country's largest standalone Islamic lender, has less than half the assets of Maybank Islamic.
"Our model leverages on the joint network. I am personally not so keen to set up branches," said the chief executive of another Malaysian Islamic bank, noting: "We are bottom line-driven." The executive declined to be named.
This contrasts with the Gulf, which has major, standalone Islamic banks such as Saudi Arabia's Al Rajhi Bank, Bahrain's Al Baraka Banking Group and Abu Dhabi Islamic Bank.
Using conventional bank branches reduces costs and risks. But it can also reduce the appeal of Islamic banking to some customers, while it may dilute management's focus on the Islamic side of the business and constrain the Islamic operation's room for maneouvre.
Malaysian regulators have been actively promoting the concept of creating a very large, standalone Islamic bank, and have even created a specific licence for such a "mega" bank. It would be defined as having paid-up capital of $1 billion, compared to 300 million ringgit for a regular banking licence.
The theory is that such a large Islamic bank could compete because of its size and also because it would be able to choose its strategy independently from a conventional parent. So far, however, there has been little concrete interest in the financial community to establish such a bank.
"If Malaysia wants to maintain leadership then this initiative, under whatever name, needs to be done," said Nazim.