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