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Assessing production efficiency of Islamic banks and conventional bank Islamic windows in Malaysia Kamaruddin, Badrul Hisham; Safa, Mohammad Samaun and Mohd, Rohani MARA University of Technology

08. March 2008

Online at http://mpra.ub.uni-muenchen.de/10670/ MPRA Paper No. 10670, posted 21. September 2008 / 16:23

Assessing Production Efficiency of Islamic Banks in Malaysia

ISSN 1985-3599

Research paper

Received 07 March’08/Accepted 10 May’08

Assessing Production Efficiency of Islamic Banks and Conventional Bank Islamic Windows in Malaysia ♣

Badrul Hisham Kamaruddina Mohammad Samaun Safab, Rohani Mohdc abcFaculty

of Business Management, University Technology MARA, Malaysia

Abstract This study presents new perspectives on performance evaluation of Islamic banking operations in Malaysia, by investigating for the first time, both cost and profit efficiency of full-fledged Islamic banks and Islamic window operations of domestic and foreign banks. The application of Data Envelopment Analysis (DEA) technique has provided several efficiency measures such as allocative, pure technical and scale efficiency that explain cost and profit efficiency differentials among banks. The findings of the study show that Islamic banking operators are relatively more efficient at controlling costs than at generating profits. The main contributor for cost efficiency of domestic and foreign banks comes from resource management and economies of scale respectively. These findings have implications on the reform process carried out in the aftermath of Asian financial crisis, particularly the Financial Sector Master Plan (FSMP). Keyword Data Envelopment Analysis, allocative efficiency, technical efficiency, foreign banks

INTRODUCTION Interest-free banking is growing in Malaysia very quickly and widely accepted by the public, standing at an average rate of 19 percent per annum in terms of assets since 2000. By the end of 2004, total assets of the Islamic banking sector increased to RM 94.6 billion which accounted for 10.5 percent of the total assets in the banking system. The market share of Islamic deposits and financing also increased to 11.2 percent and 11.3 percent of total banking sector deposits and financing respectively (Bank Negara Malaysia, 2004). This is contributed by 2 ♣

bsham_uitm@yahoo.com

International Journal of Business and Management Research, 1(1): 31-48, 2008

31

Assessing Production Efficiency of Islamic Banks in Malaysia

ISSN 1985-3599

Islamic banks regulated and supervised under the Islamic Banking Act; 13 commercial banks, 3 finance companies and 4 merchant banks. The latter three types of interest-based banking institutions offer interest-free banking through special outfits called ‘Islamic windows’. Islamic windows are departments within conventional banks set up, operating and maintaining Islamic banking operations as profit and cost entities separate from their conventional banking operations. Malaysia pioneered the implementation of Islamic widows for Islamic banking. Due to the success, the Islamic window set up serves as a model for Islamic banking systems in other countries such as Indonesia and Thailand. The main issue is the unavailability of documented evidence on both cost and profit efficiency of Islamic banking operations. Most of the past studies focused on either cost efficiency or profit efficiency (Fare et al., 2004; Fitzpatrick and McQuinn, 2005; Akhigbe and McNulty, 2005). A study on one aspect of efficiency does not provide a comprehensive assessment of a state of efficiency of a bank. Studies by Chu and Lim (1998), Isik and Hassan (2002) and Maudos and Pastor (2003) emphasize the importance of investigating both cost and profit efficiency in the analysis of bank production efficiency. However, these studies were conducted on conventional commercial banks in Singapore, Turkey, Spain, and Australia respectively. Meanwhile,...
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