Efficiency of Islamic Banks: A Comparative Analysis of MENA and Asian Countries

By Rahman, Abdul Rahim Abdul; Rosman, Romzie | Journal of Economic Cooperation & Development, March 1, 2013 | Go to article overview

Efficiency of Islamic Banks: A Comparative Analysis of MENA and Asian Countries


Rahman, Abdul Rahim Abdul, Rosman, Romzie, Journal of Economic Cooperation & Development


It is crucial for Islamic banks to be efficient in order to withstand competitive pressures and financial crises. This study empirically examines and compares the efficiency of selected Islamic banks in Middle Eastern and North African (MENA) countries (including Gulf Cooperation Countries) and Asian countries. The efficiency scores were measured using data envelopment analysis based on the intermediation approach. The sample was comprised of 63 Islamic banks, focusing on performance for a four year period (2006 to 2009).

The study finds that the main source of technical inefficiency among the Islamic banks is the scale of their operations. The Islamic banks, in general, achieved a high score for pure technical efficiency, indicating that the banks' management were able to efficiently control costs and use the inputs to maximise the outputs regardless of scale effects. On average, Islamic banks from Asian countries are found to be relatively more efficient than those in MENA countries. Interestingly, most of the efficient Islamic banks were from Gulf Cooperation Countries. The economic condition of a country is found to be the main determinant of an Islamic bank's efficiency.

Introduction

The recent global financial crisis brought the Islamic financial industry into the spotlight as a possible alternative for investment and banking (Smola and Mirakhor, 2010). Islamic financial institutions have a relatively high market share in several emerging markets, such as Malaysia and several Middle Eastern countries (Beck et al., 2013). Islamic banking is recognised as one of the fastest growing areas in finance and has grown all over the world. The number of Islamic financial institutions worldwide has risen to over 300 in more than 75 countries concentrated mainly in the Middle East and South East Asia (Sufian and Noor, 2009). Countries like Malaysia and Bahrain are striving to be regional hubs for Islamic financial services (Ariss, 2010).

Despite the rapid growth of the Islamic banking and finance industry, analysis of Islamic banking at a cross-country level is still in its infancy (Sufian and Noor, 2009). Furthermore, cross-country analysis - in particular of MENA and Asian countries - is important as most of the well-established Islamic banks are operating in these countries.

The aim of this study is to fill the gap in the literature by providing empirical evidence on the efficiency of Islamic banks in MENA and Asian countries during the period 2006 to 2009. Interestingly, the study period includes the occurrence of the financial crisis of 2007/2008 following the subprime meltdown in the United States, which affected the global financial system including Islamic banks that work side-by-side with the conventional banks.

Review of the Literature

Extensive studies have been conducted on bank efficiency, with most focusing especially on geographical regions and individual countries. Many studies have focused on the US (see, for example: Aly et al., 1990; Spong et al., 1995) and on European countries (see, for example: Favero and Papi, 1995; Pasiouras, 2008b). Other studies have focused on the banking industry in Middle Eastern countries, for example, in Turkey (see, for example, Isik and Hassan, 2002a and 2002b), Kuwait (see, for example, Darrat et al., 2002) and Jordan (see, for example, Maghyereh, 2004); countries in Asia, for instance, Malaysia (Omar et al., 2006; Mohd. Tahir et al., 2009), China (Ariff and Can, 2008; Avkiran, 2011) and India (Sathye, 2003); and in Oceania, such as Australia (see, for example, Sathye, 2001; Sturm and Williams, 2004).

Moreover, there are many studies that have conducted cross-country efficiency analyses, for instance, the work of Berg et al. (1993), Allen and Rai (1996), Hassan et al. (2000), Diestsch and Lozano-Vivas (2000), Chaffai et al. (2001), Mostafa (2009), Pasiouras (2008a) and Sun and Chang (2011). However, only a few studies have focused particularly on the Islamic banks (see, for example: Hassan and Hussein, 2003; Yudistira, 2004; Hassan, 2006; Sufian, 2006, 2007; Ahmad Mokhtar et al. …

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