A comparison of performance of Islamic and conventional banks 2004–2009

Abstract

We compare the efficiency of Islamic and conventional banks during the period 2004–2009 using data envelopment analysis (DEA) and meta-frontier analysis (MFA). The use of the non-parametric MFA allows for the decomposition of gross efficiency (i.e. the efficiency of banks when measured relative to a common frontier) into 2 components: net efficiency (the efficiency of banks measured relative to their own bank type frontier) and type efficiency (the efficiency which relates to modus operandi). This approach is new to the Islamic banking literature. The analysis is performed in two stages. The first stage employs DEA and MFA to compare banks on the basis of gross efficiency and its components (net and type). We find that Islamic banks are typically on a par with conventional ones in terms of gross efficiency, significantly higher on net efficiency and significantly lower on type efficiency. Second stage analyses, which account for banking environment and bank-level characteristics, confirm these results. The low type efficiency of Islamic banks could be attributed to lack of product standardization whereas high net efficiency reflects high managerial capability in Islamic banks. These findings are relevant to both policy-makers and regulators. In particular, Islamic banks should explore the benefits of moving to a more standardized system of banking, while the underperformance of conventional bank managers could be examined in the context of the on-going remuneration culture.