Efficiency and stability of Islamic vs. conventional banking models: a meta frontier analysis

Abstract

ABSTRACT This paper aims to compare the efficiency, technological gap, and stability of Islamic and conventional banks in the GCC region. We estimate group-specific cost frontiers for each banking type, and a Meta cost frontier for all banks to draw insights on the technological heterogeneity between the GCC Islamic and conventional banks. In the second stage analysis, we use the Generalized Method of Moments (GMM) to highlight the major determinants of bank efficiency in GCC countries. We also investigate the differences, if any, in the stability of Islamic and conventional banks against the 2007–08 global financial crisis. A panel dataset of 72 banks over the period 2005–2011 that covers the crucial period of the global financial crisis is used for the analysis. The results show that there is no statistically significant difference in mean efficiency between Islamic and conventional banks when efficiency is measured relative to the group frontier. But, Meta Frontier Analysis that accounts for the differences in the modalities of the two banking systems reveals that Islamic banking technology is not at par with the industry’s standard. The decomposition of the efficiency scores indicates that the pure technical efficiency of Islamic banks is significantly higher than that of conventional banks, but Islamic banks are posed to higher dis-economies of scale. The analysis further reveals that the 2007–08 financial turmoil has moderately affected the GCC banking sector; we found no evidence of statistically significant differences in the resilience levels of Islamic and conventional banks against the financial crises.