Efficiency in Islamic Banking

Abstract

This chapter provides an overview of the literature that deals with measuring bank efficiency and shows recent empirical evidence that has sought to compare cost and profit efficiencies of Islamic and conventional banks. The first part of the chapter deals with the main methodological issues associated with estimating bank efficiency and outlines the main parametric and non-parametric approaches currently used in the literature. It then goes on to discuss features of the bank production process and finishes off with a review of recent studies that compare the banking sector efficiency of Islamic banks in GCC countries, Egypt, Jordan, Turkey and Sudan. Other studies that solely focus on Islamic banks are also briefly discussed. The main finding from this (albeit recent and limited) literature is that Islamic banking as a production process is almost always found to be more cost and profit efficient than conventional banking. This is perhaps due to the lower funding costs and loan-loss levels in Islamic banking as compared with other types of banking operation. This phenomenon, amongst others, may explain why we continue to see high growth rates of Islamic banking practice internationally.