Effiecieny of Islamic Banking in Malaysia

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Efficiency of Islamic Banks in Malaysia

Mariani Abdul Majid*
NOR GHANI MD. NOR**
FATHIN FAIZAH SAID

ABSTRACT

IN RECENT YEARS, MALAYSIAN ISLAMIC BANKS HAVE TO OPERATE IN AN INCREASINGLY COMPETITIVE ENVIRONMENT. THIS TREND IS EXPECTED TO CONTINUE AS THE COMPETITION FROM CONVENTIONAL BANKS PICKS UP, PARTLY IN RESPONSE TO THE ASEAN FREE TRADE AGREEMENT (AFTA), BUT ALSO IN RESPONSE TO THE GENERAL GLOBALIZATION OF MARKETS. HOW ISLAMIC BANKS WILL BE AFFECTED BY THE INCREASED COMPETITIVE PRESSURES DEPENDS IN PART ON HOW EFFICIENTLY THEY ARE RUN. THIS PAPER EXAMINES THE PRODUCTIVE EFFICIENCY OF MALAYSIAN COMMERCIAL (ISLAMIC AND CONVENTIONAL) BANKS OVER THE 1993 TO 2000 TIME PERIOD. THE GOAL OF THE ANALYSIS IS TO IDENTIFY THE EFFICIENCY LEVEL OF ISLAMIC BANKS COMPARED TO OTHER COMMERCIAL BANKS IN MALAYSIA. USING THE STOCHASTIC FRONTIER COST FUNCTION APPROACH, EFFICIENCY SCORES WERE DETERMINED FOR EACH BANK TO DETERMINE THEIR RELATIVE POSITIONS ON THE EFFICIENCY LADDER. AN INEFFICIENCY MODEL IS ESTIMATED TO LINK THE INEFFICIENCY OF INPUT USE TO PRODUCE OUTPUT TO OTHER FACTORS. THE RESULTS SHOW THAT THE EFFICIENCY LEVEL OF ISLAMIC BANKS IS NOT STATISTICALLY DIFFERENT FROM THE CONVENTIONAL BANKS. IN ADDITION THERE IS NO EVIDENCE TO SUGGEST THAT BANK EFFICIENCY IS A FUNCTION OF OWNERSHIP STATUS I.E. PUBLIC OR PRIVATE, AND FOREIGN OR LOCAL.

1. Introduction

During the early years after independence, foreign banks dominated the Malaysian banking scene. For instance, two years after independence (1959), there were only 8 local banks out of the 26 commercial banks in operation. Twenty years later, the role played by the local banks improve considerably when the number of commercial banks increased to 38 with 21 domestic banks and 16 foreign banks in 1982. The number shrank considerably (although the split between local and foreign banks is maintained) in the 1990s following a spate of ‘mergers and take-overs’ as banks try to secure particular niches and economies of scale in order to stay competitive. By August 2001, there were 27 commercial banks in total including 2 Islamic banks.

Along side the conventional banking system, the Islamic banking system has steadily evolved to become a major player on the Malaysian financial landscape. Its birth could be traced back to the establishment of the Pilgrimage Fund and Management Council (LUTH) in 1969; although its function was then limited to mobilizing savings for Muslims who wish to perform Hajj in Mecca. The establishment of Bank Islam Malaysia Berhad (BIMB) in 1983 really marks the beginning of a new era in Islamic banking in Malaysia. The year witnessed the creation of a full-fledged Islamic banking institution offering financial services in accordance with Islamic jurisprudence. The Islamic banking system received a further boost when a scheme where conventional banks can open windows for Islamic banking products called Interest-free Banking Scheme was launched in 1993. Another important event for Islamic banking in Malaysia occurred in October 1999 when the second Islamic bank, Bank Muammalat Malaysia Berhad (BMMB) opened its door to the public. By the end of 2001, there were 36 conventional banking institutions offering Islamic banking products in Malaysia (14 commercial banks, 10 finance companies, 5 merchant banks and 7 discount houses) besides 2 full-fledged Islamic banks (Bank Negara Malaysia, 2001).

Despite its growth, the share market of the Islamic banking system in Malaysia is relatively small compared to the size of the overall banking system. Herein lies one of the reasons for assessing the efficiency of Islamic banks relative to their conventional counterparts. Efficient operation will not only ensure its survival through growth but will also practically demonstrate that the Islamic financial system is the alternative to the currently adopted system. By end of October 2001, the total assets of RM59.0 billion belonging to Islamic...
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