EFFICIENCY IN ISLAMIC BANKING
Australian Expert Writers
Introduction of the literature review
Non-interest banking principles are derived from the Sharia law which governs the Islamic banking institutions. Islamic economics and Sharia law are prominent for guiding this type of banking system. This banking system is different from the conventional interest payment banks because Islamic banks rely on the sharing of profit and loss, not into the interest payment (Iqbal and Molyneux, 2016). The Islamic laws prohibit the collection of ‘riba’ or ‘interest’ as directed in the Quran.
Nowadays, the Sharia-compliant principles in the banks have increased from the origin of such an Islamic banking system. Hence, it can be said that the efficiency of the Islamic banking system has increased in recent years. The following literature review will critically evaluate the efficiency of Islamic banking and review the different results with this topic by considering opinions from different authors.
Islamic banking is becoming popular in various countries such as Southeast Asia, Asian countries, United Arab Emirates, Iran, Kuwait etc (Islamic banking Abd, 2019). This banking system is increasing in various areas which increase the dependency of the countries. This is increasing in the last two decades in the Asian countries due to various reasons such as rapid Muslim growth, living standards enhancement and others. The inline religion believes contributes to growing over the products and services. The government of those countries is promoting the Islamic banking system in a motto to attract more investment for sustainable funding. This will enhance the economic growth of the country in the long run. This is to ensure that the financial institutions are going to improve the stability and international banking system.
The Islamic banking system and its principle
The Islamic banking system does not work on the basis of conventional interest sharing principle; it follows the profit-sharing principle by equity participation. This means the bank will share profit to the consumers and borrower instead of paying interest. Some Islamic banks also use windows for providing services to consumers.
The efficiency of Islamic banking
It is clear that the demand for Islamic banking products is increasing in recent years (Gheeraert and Weill, 2015). In order to measure the efficiency of the Islamic banking industry, one should compare the microeconomic efficiency and total productivity. Gheeraert and Weill, (2015) have concluded that there is evidence of development for favoring the efficiency of the Islamic Banking system. It has been shown in the paper that there is a non-linear relation for efficiency and development. It is also noteworthy that Islamic banking will be efficient if there is limited number of developments (Samad, 2018). It has been also found in this report that Islamic banking will also have an unfavourable effect on the efficiency of the banking system. However, this paper also shows some interesting results in several countries. Apart from this, it has been also represented in this article that the development of conventional banks may not have an efficient trend.
The development and the efficiency of the banking industry are totally different. This paper also failed to show evidence of the profitability of the conventional banking system over the Islamic banking system. In terms of comparison between the above two, it can be stated that Islamic banking will not be a problem for product comparison. As per the views of Naceur, Barajas and Massara, (2015), the efficiency measurement strongly uses the liquidity, operational risks, credit and others. The debt ratio, liquidation costs, volatility and other areas. The spread between the deposit rate and the riskless interest rates are totally different.
On the other hand, Said, (2013) has stated that the reason behind inefficiency banks has resulted from the negative relationship. This can create a regular problem (credit risks and others) in the internal costs, credit risks and bad management of costs. It is also evident in that paper that the efficiency of the Islamic banks is determined by the use of credit risks, liquidity risks and operational risks. If the above risks factors improve drastically then it can improve the efficiency of the Islamic banks.
According to the views of Imam and Kpodar, (2013) it can be stated that if the Islamic banks successfully increase the efficiency then there will be proper management of services for a sustainable future. Increased efficiency may lead to the success and development of a country. As a result of this, the existing gap for measuring efficiency will reduce. The higher capitalisation of the Islamic banks attracts higher liquidity for performance management in the troubled situation.
As argued by Hanif, Tariq and Tahir, (2012) it can be stated that there are no major differences in efficiency between the Islamic and the conventional bank. However, this is not applicable everywhere. This is noticeable for the profit, revenue, costs, resources and others. It can be stated from the above discussion that the average and the overtime efficiency of the Islamic banks are based on the dynamic panels, region, age, size etc.
In contrary to the previous opinion, Iqbal and Molyneux, (2016) have stated that the liquidity and profitability management of the conventional banks are comparatively higher than the Islamic banks. It is also evident in that paper that the solvency, performance and risks management is better in the Islamic banking area. Hence, it can be said that the Islamic banking system is not always bad because of the soundness and strengths over the conventional banking system. It has been also seen in the paper that, satisfaction of the customers is prominent in both the conventional as well as the Islamic banking system. However, it can be said that the USP of Islamic banking is comparatively low because the conventional banks are having different types of banking products.
Abedifar, et al. (2015) have revealed that credit risks are more frequent with the Islamic banking system because of the low level of recoverability compared to that of the conventional banks. Insolvency risks and credit risks are comparatively higher in Islamic banks. Hence, it can be stated that the efficiency of the Islamic banks will be affected by this negative influence (Afaq, et al. 2019). It has been also found in that paper that the Islamic banks are taking more risks compared to the non-Islamic banks because of the unfamiliarity and lack of experience with the financial tools. Hence, it can be said that there should be an effective capital management tool for the Islamic banking system.
Conversely, Abduh, Hasan and Pananjung, (2013) have stated that the Shajalal Islami Bank limited is better than the other Islamic banks in Bangladesh when it comes to consideration of the Return on Equity, Return on Assets, ETA etc. It has been also found that the rest Islamic banks are also showing improvement in the efficiency level. In terms of efficiency, the Islami Bank is better compared to other Islamic banks in Bangladesh. However, there is a gap in this literature because the author has not represented the efficiency difference between conventional banks and Islamic banks. This opinion can be compared with the previous studies and it can be said that the efficiency of Islamic banks can be improved with the appropriate use of capital management tool. Furthermore, this article shows that there is an increasing trend in efficiency after 2006 (Nosheen and Rashid, 2019). It is already known that the efficiency of the Islamic banks is more in the Asian countries compared to that of the Western countries; this is evident in this case. It has been found that the Islamic banks are very efficient at 98.19% when it comes to returning on the asset ratio. It was also found that the return on equity ratio of these Islamic banks in the south Asian countries are about 91.4% in respect to net profit ratio (Irfan, Majeed and Zaman, 2014). It has been found that Pakistan, Bangladesh and other south Asian countries are toppers when considering the efficiency of the Islamic banking system.
Yudistira, (2004) has mentioned the performance, stability and risks in the Islamic banking from 1999 to 1999. It has been found that the Islamic banks were inefficiency situation in the global crisis during that period. It has been also found that the environmental influence, size of the bank, international environment and other factors (Jan, et al. 2019). Hence, it is clear that Islamic banks are often facing more challenges due to various factors. This is a big challenge for Islamic banks for the coming years.
The efficiency of the banks during the financial crisis
As per the views of Rosman, Wahab and Zainol, (2014) it has been found that the Islamic banks were able to survive with sustainable performance even through the financial crisis. It has been also found that the majority of the Islamic banks were inefficient during that time of financial crisis. It was also found that the majority of the banks (inefficient banks) are operating at decreasing return. This study also shows that the capitalisation and profitability are two major important for the determination of banking efficiency (Safiullah and Shamsuddin, 2019). There is policy implementation for improving the performance of the Islamic banks at the efficiency level.
Alternatively, it has been seen that the technical efficiency of the Islamic banks is higher in the Asian countries compared to that of the Middle Eastern countries. An average score of the Asian Islamic banks was in between 61 percent and 75 percent. On the other hand, the average score of efficiency of the Islamic banks in the Middle Eastern countries was between 40 percent and 54 percent (Khan, et al. 2018). These differences arise because there are varieties of Islamic banks in the Middle Eastern countries.
On the contrary Said, (2013) has revealed that the insolvency risks in the small Islamic banks are comparatively stable than other banks in the society. The loan quality of the Islamic banks is not that responsive because of the difference between the domestic interest rate in Islamic banks and conventional banks.
The efficiency of conventional banks and Islamic banks
As pointed out by Ismail, Shabri Abd. Majid and Rahim, (2013) it can be stated that the technical efficiency contributes to the cost efficiency for the commercial banks. On the other hand, the locative efficiency for the Islamic banks operates for cost-efficiency. It was also derived from the above article that commercial banks are more efficient in terms of utilizing information on electronics and technology in the banking system. In addition to that, it can be stated that Islamic banks are very efficient in utilizing resource and allocation. The scale or window efficiency is present for both the Islamic and conventional commercial banks. Hence, it can be stated from the above that the size of the banks and area of services are very important for determining the efficiency of the banks.
Growth of a bank or institutions is the indicator of success because the banks are making profit and capitalisation of such profit. As per the views of Irfan, Majeed and Zaman, (2014) it can be stated that the Islamic banks are growing at the rate of 18 percent per annum after 2004 in Asian countries. The growth of the Islamic banks can be related to the overall efficiency of the banks (Faye, Triki and Kangoye, 2013). There are regulatory authorities which control the regular information for the facilitation of the new banking system in the country. However, it was also manifested that the banking environment can be a negative to the cost efficiency; this means the environment will attract additional costs for the banks thereby reducing the efficiency of the banking business (be it Islamic or conventional). However, there is a solution to increase the profitability of Islamic banks by increasing the number of branches. There are other financial factors which control the efficiency on the impact.
Figure 1: Islamic Banking Assets (percentage) of the Malaysian banking assets from 1996 to 2007
(Source: Sufian, Kamarudin and Noor, 2013)
From the above it is clear that the assets of the Islamic banking system have an increasing trend. The percentage of the asset was 1.2 in 2012, which has increased to 12.8 in 2008 (Sufian, Kamarudin and Noor, 2013). This means Islamic banking assets has increased by 10 times (approximately). Apart from that, further evidence has been collected in this area so it can be said that the efficiency and growth of the Islamic banks in south Asian countries are very prominent.
Profitability and efficiency
The profitability aspect and efficiency have helped the financial ratios for the Islamic banks. It has been seen that the technical, pure technical and other areas in the Islamic banking sector. The efficiency in the Islamic banking refers to the efficiency in the spending (cost, allocation of resources and others) in respect with the earnings of the business (revenue and income) (Sufian and Kamarudin, 2014). In addition to that Shah, Shah and Ahmad, (2012) have stated that the Islamic banks are technically efficient compared to the traditional banks in loan-based approach. The findings of this research paper further revealed a contradictory result that the Islamic banks are less efficient in the matter of technical efficiency when compared with the former banks. When compared with the total marked-up expenses under the income-based approach the existing banks are way better than the Islamic banks. This kind of inefficiency has resulted from the technical fault. The efficiency of the technical area of the Islamic banks is related to the total mark-up expenses, ownership, total liabilities and others (Shah, Shah and Ahmad, 2012). The efficiency can be improved by improving the previous factors under the loan base approach. Total liabilities, ownership and total profit will have a significant impact on the technical efficiency under the income-based approach.
On the other hand, Abu-Alkheil, Burghof and Khan, (2012) have stated that the inefficiency is not only resulted from lack of profit, mark-up expense etc but also inadequate management system. Small Islamic banks in the UK and other Islam majority countries are lacking appropriate management. Hence, the Islamic banking system is not very efficient in terms of non-optimal size.
As per the views of Imam and Kpodar, (2015) the conventional banks are having a long presence in Pakistan since the independence of Pakistan. Islamic banks are equally performing like conventional banks. However, there should not be such in-effective management in the Islamic banking system. There is a difference in the principle that is sharing profit instead of interest to the consumers. There is an agreement between the provider and the borrower of the funds (Rusydiana and Sanrego, 2018). However, the profit-sharing is not done in advance and it is distributed according to the risks. Islamic banks often take fee and commission in the transaction. However, these banks do not charges or pay any interest (Hassine and Limani, 2014).
The result of the present study shows that the revenue efficiency of the domestic Islamic banks is relatively lower compared to their foreign peers due to the difference between the cost and profit efficiency levels. In addition, the empirical findings of the present study suggest that the foreign Islamic banks in Malaysia exhibit higher efficiency levels for all three efficiency measures (cost, revenue and profit efficiencies). In essence, revenue efficiency seems to play the main role in lower or higher profit efficiency levels. Furthermore, the results for the domestic Islamic banks show that the level of cost efficiency is higher than profit efficiency due to the lower revenue efficiency levels. Meanwhile, the level of cost efficiency is slightly higher than profit efficiency due to the higher revenue efficiency level among the foreign Islamic banks in Malaysia (Johnes, et al. 2018). Hence, it can be said that the Islamic banks are having competition with the conventional banks but the efficiency of the Islamic banks has remained low for a while (Kalim and Arshed, 2018). However, these banks can increase the return (i.e. profit share) to the borrowers by operational efficiency and technical efficiency. The deposit returns can be maximized by the help of the investment portfolio return so the banks can access more funds. It is clear that this study emphasises on the public benefits by paying attention to the costs. The study has examined Islamic banks from Malaysia, Pakistan and other countries and analysed the frontier between 2001 and 2015. This study gives an idea about the Islamic banks in terms of optimization but this has not stated the efficiency of those banks. Investment in a banking business pushes efficiency in terms of spending compared to the earnings.
On argument with the previous views, ADA and DALKILIÇ, (2014) have stated that there was a declining trend with Islamic banking in terms of the efficiency compared to the traditional banking facilities. The author further represented that efficiency is sensitive to the profitability and loans of the business. There are other factors which also affect the profitability of the business depending on the structure, operation and other factors of the Islamic banks.
Abu-Alkheil, Burghof and Khan, (2012) the bank production process includes recent studies for comparison with the banking sector. The banking sector efficiency in the Sudan, Jordan, Turkey and other area are prominent. The production process of the Islamic banking system refers that the cost and profit-based efficiency. The loan and the funding sector of Islamic banking should be compared with the banking operation of the Traditional banking sector before stating any comment. The high growth rate of Islamic banking practice should follow international practice.
Different types of efficiency
According to the views of Gishkori and Ullah, (2013) it can be observed that the technical efficiency of the banks is improving after 2008 in Pakistan. On the other hand, it can be stated that the twenty-seven banks are efficient compared to another banking system. When it comes to the comparison between the Islamic banks and the conventional banks it will be a completely different scenario (Gishkori and Ullah, 2013). It is evident that the previous discussion that the efficiency of the Islamic banks is comparatively lower than that of the conventional banks. This case has used 34 different banks from foreign, conventional and Islamic banks. The technical efficiency has been measured by the use of a constant return to scale. It was also found that the scale efficiency of the banking system is close to each other. On the other hand, there is variance at the time of counting the technical efficiency for the banking sector. The difference between technical efficiency can bring a negative impact on society.
In contradictory, Tajgardoon, Behname and Noormohamadi, (2012) it can be stated that there might be a significant rise in the takeovers by the FDI and foreign banks but the profit of the banking sectors are not explained properly in the business. The profitability of Islamic banking countries is increasing drastically. Hence, it can be said that efficiency can be the main force of increasing competition in the market. It can be also said that the Islamic countries are expected to be benefited by the improved efficiency in the country. However, other approaches are evident in that paper which presents that removing barriers can create a competitive market in the Islamic banking industry (Kusuma and Ayumardani, 2016). Hence, it can be said that the decentralised system can be established in Islamic countries by the introduction of the efficient Islamic banking system.
As stated by Sufian and Kamarudin, (2014) the empirical findings of this study represented that the efficiency of the Bangladesh Islamic banking sector has to be very efficient. When it comes to the agreement of the profit efficiency in a banking business the production scale will be utilised heavily instead of the utilization of the resources. The dominant effect of the inefficiency states that the Bangladesh banks are operating in an incorrect way because of the structure (Alam, 2012). The experience economic scale is limited due to the perfect implementation of the optimum size. Hence, it can be said that the increasing and the decreasing scale of production has a direct effect on the efficiency as well as cost savings of the business (Al Arif, Haribowo and Suherlan, 2018). Hence, it can be said that the managers of the Islamic banks have to be very effective and they should have a clear understanding of the impact of profit efficiency on the business. It is also expected that the developing countries like Bangladesh will have the latest technologies for improving the level of performance alongside efficiency. The main motive of the banking business is to increase profit and grow constantly.
It can be concluded from the above discussion that the Islamic banks are just like the traditional banks but the working process of these banks are different because these banks share profits instead of the interest. Apart from that many authors have measured the efficiency by comparing spending with its earnings but some authors also compared the efficiency with the technology and operational efficiency. In the same area, conventional banks are better because of the availability and usage of technology in operation. It is also clear in the above discussion that the Islamic banks are attracting a low level of investment. However, this can be mitigated in the future. It was also an event that Bangladesh is having comparatively better technology for which the Islamic banking system is quite better here. It was also derived from the above that the Islamic banking efficiency (in terms of profitability) is quite better in the south Asian countries compared to that of the Western countries.
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