The better efficiency of Islamic banks: is it due to Islamic financial principles or to Islamic banking practices. Comparison of the various Islamic banking practices: GCC versus Malaysian Islamic banks
| Author | Faten zoghlami |
| Position | Doctor and Assistant professor in finance, high institute of business administration and accounting, Manouba University, Tunisia |
Since the early 1990s, the efficiency of financial institutions is a subject that continues to interest academics. The interest towards the efficiency of financial institutions is justified by its crucial and important economic implications.
An efficient financial system promotes economic prosperity, growth of wealth and reduces inflation levels.
It is precisely because of its magical effect on economy prosperity, that studies focused on the efficiency of financial institutions have become an important part of banking literature (Berger and Humphrey, 1997). Some were interested in developing literature that propose models for measuring the efficiency levels of a bank, others are dedicated to the identification of parameters promoting banking efficiency through essentially comparative studies among intra and international banks
However, and while there has been extensive literature on the efficiency of US and European conventional banking industries over the recent years (Berger and Mester 1997, Berger and Humphrey, 1997; Goddard et al.,2001; Weill, 2004; Bos and Kool, 2006; and Bader, 2007, Akhtar 2002), empirical work on the efficiency of Islamic banking, is still in its infancy.
Typically, the studies on Islamic banks have focused on theoretical issues, and empirical work has relied mainly on the analysis of descriptive statistics rather than rigorous statistical estimation (El-Gamal and Inanoglu, 2004; 2005).
Nevertheless, studies in this group can be divided into two folds: (1) studies that evaluate efficiency of Islamic banks (Yudistria, 2004; Brown and Skully, 2005; Hassen, 2005; Bader, Ariff and Taufiq, 2007), (2) studies that compare the efficiency of Islamic with conventional banks (Al-jarrah and Molyneux, 2003; Al-shammari, 2003; Hussein, 2003, 2004; Bader, Shamsher and Taufiq, 2007, Bashir 1999, Samad 1999).
Again, these existing comparative efficiency’ studies can be classified into two groups. The first groups includes studies that asses the higher Islamic banking efficiency compared to the conventional banking and refer the better Islamic bank efficiency to the Islamic financial principles i.e. interest prohibition, asset backing and the share of profits and losses. The authors especially argue that such principles implied lower funding costs and lower loan-loss levels. (eg. Al-Shammari (2003), Al-Jarrah and Molyneux (2003), El-Gamal and Inanoglu (2002), (2004)…).
The second group of studies don’t confirm the better Islamic banking efficiency and argue that there are no significant differences between the conventional and the Islamic banking efficiency.
But which is revealing from this review is the following: we notice that whenever the sample of Islamic banks includes Malaysian Islamic banks, the better Islamic banking’ performance efficiency becomes not significant.
Such statement has three main important implications: first, it becomes not suitable to generalize the finding that the Islamic banks are more efficient than the conventional ones, as did Iqbal and Molyneux (2005). Second, it appears evident that the GCC Islamic banks, who often document higher efficiency scores, are not representative of all the Islamic banks. Third, it seems fair to reexamine the role of the Islamic principles that unify all Islamic banks in drawing efficiency.
Inserted into these reflections, this paper argues that the bank’ practices are the determinant of its efficiency level rather than its ideological framework and principles.
In particular, this paper aims (1) to highlight the high heterogeneity and the so different practices used into the Islamic banks, especially between the Malaysian and the GCC Islamic banks and (2) to explore the role of such different practices on the banks’ efficiency level.
To fulfill our objective, we proceed in two steps. First we compare between the GCC and Malaysian Islamic banks efficiency, second we try to seek of the sources of the different efficiency levels into the practices used into each set of banks.
The main contribution of this paper is the comparison between two sets of Islamic banks. We recall that most of the studies interested with Islamic banking, lead comparison between Islamic versus conventional banking, assuming that all the Islamic banks are homogenous. Such assumption is far from the reality which attests high heterogeneity level among the Islamic banks.
Especially, the paper tries to answer to this question:
Do the Islamic banks d raw their better efficiency scores from the Islamic principles or from particular Islamic practices?
Although the consensus of the almost all the Islamic banks about some particular financial Islamic principles, such as interest prohibition, asset backing and the share of profits and losses, it is well known that we document many different Islamic practices among the Islamic financial institutions. Especially, we document wide conceptual and accounting differences between the Malaysian Islamic banks and the GCC Islamic banks. In fact, these differences are not surprising since the two sets of banks are referring to two different Islamic thought’ schools. The Malaysian Islamic banks fit into the Shafii School but the GCC Islamic banks fits into the Maliki School.
This study reveals significant different cost and profit efficiency scores between the Malaysian Islamic banks and the GCC Islamic banks. This revealing finding implies that the financial Islamic principles couldn’t be the unique and the main source of better efficiency.
Moreover, the paper assigns the different cost and profit efficiency’ scores to some different practices and different shariaa concept contract underlying the deposits accounts and the financing products.
Our comparative study documents the following results (1) the GCC Islamic banks profit of free funding resources, while the Malaysian Islamic banks distribute income to all the deposits’ accounts, (2) the Malaysian Islamic banks work under higher constraints of liquidity and profitability, (3) the GCC Islamic banks seem more selective, prudent and cautious in the use of shariaa concept contracts (4) the billing way especially assigned on floating margins expose the Malaysian Islamic banks to higher credit and interest rate risk levels.
All these different proceeding ways, let us anticipating and understanding the better efficiency scores documented by the GCC Islamic banks, which appear to be more advantaged in terms of cost and availability of resources and also, in terms of the offered financing products which are more expensive and less risky.
The rest of the paper is organized as follows: the section 2 gives a brief overview of the main studies dealing with the Islamic banks’ efficiency, section 3 deals with the measure methodology and results of the profit and cost efficiency scores of both the GCC and Malaysian Islamic banks. The section 3 deals with the methodology and the results of the comparative study of the different pertinent practices used into each set of banks. The conclusion is given in section 4.
Below we highlight the main studies and academic contributions that dealt with the Islamic banks efficiency. Typically all the literature was interested by comparing the efficiency scores between the Islamic and conventional banks. Nevertheless and as we said earlier, we split the literature into two fields. The first includes all studies that confirm the better Islamic banks efficiency, but the second includes studies that document no significant differences between the Islamic and conventional banks efficiency.
Al Shammari (2003) uses the translog stochastic cost and alternative profit frontier approaches to estimate bank efficiency in GCC countries and then compares Islamic bank efficiency with other types of banks. Cost efficiency estimates for banks in the countries under study averaged 88%. This suggests that the same level of output could be produced with approximately 88% of current inputs if banks under study were operating at the most efficient level. The efficiency scores based on geographical location, ranged from 83% in Qatar to 92% in Saudi Arabia. Moreover, he finds that the average cost efficiency based on bank specialization ranged from 84% for investment banks to 91% for Islamic banks. Al shammari (2003) concludes that Islamic banks have higher cost efficiency because of their generally lower cost of funds compared to commercial and investment banks.
This level of technical inefficiency is similar to the range of 10-15% found in the survey of 130 studies undertaken by Berger and Humphrey (1997).The results appear slightly lower than the levels of inefficiency found in European banking. (Goddard et al 2001).
The better efficiency score showed by the Islamic banking is also confirmed in a study led by Al-Jarrah and Molyneux (2003)(i). They also use the stochastic frontier approach, with the Fourier-flexible functional form, and estimate bank cost and profit efficiency for banks operating in Bahrain, Jordan, Egypt and Saudi Arabia. Al-Jarrah and Molyneux (2003) found that the standard profit efficiency scores ranged from 56% for investment banks to 75% for the Islamic banks. Similar results are found from the alternative profit function estimates where Islamic banks are again the most profit efficient.
El-Gamal and Inanoglu (2002) used the stochastic frontier approach to estimate the cost efficiency...
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