Islamic and Conventional Banking Efficiency: A Comparative Analysis

In this paper, employing the non-parametric DEA approach, we investigate the relative efficiency of Islamic Banks to their Conventional counterparts over the period 2002-2008. We also examine the variables of Islamic Banking efficiency using a second-step regression model approach. In a broad-spectrum, the DEA efficiency scores suggest that Islamic Banks. Efficiency is indifferent to that of Conventional Banks. In line with this finding, the regression analysis implies that Islamic banking efficiency is also indifferent. However, Islamic Banks started progressing from 2004.The reason behind that is introduction of new financial instrument ‘sukuk’. The model suggests that size and financial capital are highly contributory to banking efficiency. We also find out the correlation between the obtained DEA efficiency scores and financial ratios (ROA). We found that ROA are statistically insignificant. Hence we can possibly conclude that the DEA efficiency scores capture effects in the banking systems which are not captured by simpler measures like ROA and ROE since inputs and outputs used to compute the efficiency scores in the DEA give more information about the bank. This finding indeed may be of use to Islamic Banks since they rely heavily on the traditional simplistic measures. An important finding is that the regression results suggests that the nature of banking characteristics is not important in explaining pure technical efficiency, which further confirm the DEA finding. These arguments may signify that efficiency is related to environmental economical factors rather than bank specific characteristics.