Mariani Abdul-Majid

The Impact of Islamic Banking on the Cost Efficiency and Productivity Change of Malaysian Commercial Banks

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.

Efficiency and total factor productivity change of Malaysian commercial banks

This paper analyses the efficiency of Malaysian commercial banks between 1996 and 2002 and finds that while the East Asian financial crisis caused a short-term increase in efficiency in 1998 primarily due to cost-cutting, increases in non-performing loans after the crisis caused a more sustained decline in bank efficiency. It is also found that mergers, fully Islamic banks, and conventional banks operating Islamic banking windows are all associated with lower efficiency. The paper estimates suggest mild decreasing returns to scale, and an average productivity change of 2.37% that is primarily attributable to technical change, which has nonetheless declined over time. Finally, while Islamic banks have been moderately successful in developing new products and technologies, the results suggest that the potential for Islamic banks to overcome their relative inefficiency is limited.