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The impact of Islamic banking on the cost efficiency and productivity change of Malaysian commercial banks

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Abstract:

This study employs Stochastic Frontier Analysis (SFA) to analyse Malaysian commercial banks during 1996–2002, and particularly focuses on determining the impact of Islamic banking on performance. We derive both net and gross efficiency estimates, thereby demonstrating that differences in operating characteristics explain much of the difference in costs between Malaysian banks. We also decompose productivity change into efficiency, technical, and scale change using a generalized Malmquist productivity index. On average, Malaysian banks experience moderate scale economies and annual productivity change of 2.68%, with the latter driven primarily by Technical Change (TC), which has declined over time. Our gross efficiency estimates suggest that Islamic banking is associated with higher input requirements. However, our productivity estimates indicate that full-fledged Islamic banks have overcome some of these cost disadvantages with rapid TC, although this is not the case for conventional banks operating Islamic windows. Merged banks are found to have higher input usage and lower productivity change, suggesting that bank mergers have not contributed positively to bank performance. Finally, our results suggest that while the East Asian financial crisis had a short-term cost-reducing effect in 1998, the crisis triggered a long-lasting negative impact by increasing the volume of nonperforming loans.

Document Type: Research Article

DOI: https://doi.org/10.1080/00036840902984381

Affiliations: 1: Faculty of Economics and Business, School of Economics, Universiti Kebangsaan Malaysia, 43600 UKM BangiSelangor, Malaysia 2: Centre for Performance Measurement and Management, Aston Business School, Aston University, BirminghamB4 7ET, United Kingdom 3: Industrial Economics Division, Nottingham University Business School, The University of Nottingham, Nottingham NG8 1BB, United Kingdom

Publication date: 2011-06-01

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