Abstract
The purpose of this paper is to analyze comparative efficiency of banking system in Pakistan comprising of Islamic banks (IB), conventional banks with Islamic banking division (IBD) and conventional banks (CB). For this purpose we use two methods: First, ratio analysis to analyze cost, revenue and profit efficiency; Second, data envelopment analysis (DEA), for comparative analysis of banks’ technical, pure technical and scale efficiencies. We use efficiency scores of DEA to analyze the impact of size on the efficiency. Finally, we compare and contrast the efficiency estimates with the traditional measures of banks efficiency. We find that Islamic bank is more cost efficient and less revenue efficient. Considering their growth rate which is rudiment to scale efficiency (SE) we argue that Islamic banks should be encouraged to reach the efficient frontier in the banking industry by reducing their wastes. We further observe that hybrid banking may not be feasible form for banking industry in Pakistan. In view of the observed inverse relationship of size with scale efficiency we recommend reconsideration of the regulators’ policy of increasing the capital base of the banks thus forcing them to increase their size.
Highlights
Developing and transition economies, Pakistan alike, provide a unique opportunity to study the impact of liberalization and deregulation on the efficiency and performance of the banking sector
The purpose of this paper is to provide an in-depth analysis of efficiency of Islamic banks (IB), conventional banks (CB) and Islamic banking division (IBD) in Pakistan over the period 2003-2008 using financial ratio analysis and data envelopment analysis (DEA)
The CB has a long history and very strong and deep roots in Pakistan, while IB is in its infancy stage and the regulator’s induced IBD is a new experimentation
Summary
Developing and transition economies, Pakistan alike, provide a unique opportunity to study the impact of liberalization and deregulation on the efficiency and performance of the banking sector. Pakistan is in the process of building a strong banking platform where its central bank, State Bank of Pakistan (SBP), regulates the sector to gradually bring reforms which on one hand may open new windows of opportunity for the industry players, and on the other hand may create distortions resulting in inefficient resource allocation (Akmal & Saleem, 2008). In such a case analysis of bank efficiency is important from the point of view of investors, creditors, the government and the bank’s management (Al-Shammari & Salimi, 1998). Having the same factors of production, the efficient usage of inputs determines the success (Danesh, 2007)
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