An evaluation of Islamic versus conventional banks' efficiency : a global study

The study compares the efficiency of Islamic and conventional banks, during the period 2006-2012, by employing a non-parametric approach- the Data Envelopment Analysis (DEA). In order to minimise the bias resulting from the inherent dependency in the first stage of the DEA, the DEA outcomes were replaced with the bootstrapped estimators and replicated them 500 times. Accordingly, confidence intervals are constructed for efficiency measures, which subsequently, improved further the accuracy of the findings and provided more reliable arguments for policy implications. The study applies a two-stage Data Envelopment Analysis. The first stage of the DEA compares banks based on their Overall Technical Efficiency (OTE) and its components (Pure Technical Efficiency (PTE) and Scale Efficiency (SE)). Although proven to be more resilient during the financial crisis (Farooq and Zaheer, 2015), the research found that Islamic banks to be normally on a par with their conventional counterparts in terms of PTE and that they were significantly higher in terms of OTE and SE . In addition, according to the study’s results, both Islamic and conventional banks suffered from managerial underperformance rather than a failure in operating at optimal production levels. In other words, Islamic and conventional banks were managerially inefficient in controlling their operating costs and utilising their resources. The second stage of the DEA, which accounts for the country- and bank- specific factors, confirms the findings that there was no significant difference in PTE between Islamic and conventional banks. Moreover, the findings imply that Islamic banks have no significance on pooled PTE and show no significant difference in PTE when compared to conventional banks during the entire period of the study including the financial crisis (2007-2009). In the light of the study’s empirical findings, Islamic banks should explore the benefits of moving to more diversified investments and tools in order to make use of their liquidity. Moreover, Islamic banks have to employ more solid risk management techniques in order to limit the number of risks, including credit risk, market risk, liquidity risk and operational risk, which may arise in the shari’ah banking industry. The research is extended to study the PTE determinants of four regions, namely, MENA, East Asia and Pacific, South Asia, and Europe and Central Asia. The outcomes show that PTE had a different significance for each region’s determinants related mainly to the levels of the indicators of governance, namely, Voice Accountability (VACC) and Regulation Quality (REGQ). The findings suggested that the more developed and democratic countries were favourable to banks having more operations that are efficient. In addition, these countries’ excessive regulation and supervision (i.e. limited financial freedom), encouraged financial institutions to create unclear new instruments and misjudge the risks. These resulted in the banks being less efficient. The study found, also, that there were different determinants for Islamic and conventional banks operating in Muslim and non-Muslim countries