Abstract
This chapter surveys the literature on the productivity profiles of Islamic Banks (IBs), with a specific emphasis on Malmquist Productivity Indices (MPIs) estimated using Data Envelopment Analysis (DEA) methodologies. It examines 68 publications from 2006 to 2022, offering a comprehensive categorization of the literature based on four key aspects: (1) the type of DEA analysis, (2) productivity measurement methodologies, (3) variables for DEA model specification and corresponding evaluation approaches, and (4) the drivers of productivity along with their theoretical foundations. This paper also provides a critical analysis of the existing literature, identifying gaps, inconsistencies, and potential sources of discrepancies in the findings, thereby paving the way for future research to address these limitations.
Top1. Introduction
Banking systems are critical drivers of economic growth and financial stability in countries (Jokipii & Monnin, 2013; Athari et al., 2023). In recent decades, the global banking industry has witnessed significant transformations due to the rise of Islamic Banks (IBs) (Alam, 2013; Imam and Kpodar, 2016). Empirical studies by Hasan and Dridi (2010) and Farooq and Zaheer (2015), along with the 2010 International Monetary Fund (IMF) survey, have demonstrated that IBs were more resilient than Conventional Banks (CBs) during the Global Financial Crisis (GFC) of 2007-2008. This resilience is attributed to their higher intermediation ratio, better asset quality, and stronger capitalization compared to CBs (Beck et al., 2013). Furthermore, the General Council for Islamic Banks and Financial Institutions (CIBAFI) reported in 2022 that Islamic assets under management experienced a growth of 13.7% in 2020 during the COVID-19 pandemic, and over the last decade, the sector expanded by 300%, with assets under management nearly reaching $200 billion. These facts and the empirical evidence of IBs’ resilience have generated considerable interest from various stakeholders, such as policymakers, regulators, investors, and academics, in examining the productivity of IBs.
The motivation for studying the productivity of IBs arises from both general arguments common to the entire banking industry and arguments specific to Islamic banking. General arguments include the insights productivity studies can offer to managers and regulators regarding changes in efficiency over time (Alhassan and Biekpe, 2015; Nartey et al., 2019), the informative decompositions of productivity change for stakeholders (Khoveyni and Eslami, 2014), the expectation that increased productivity leads to better bank performance, competitive prices, improved quality of services, and better resource allocation, and the impact of recent changes in the financial services industry and technological advancements on banks’ productivity (Berger and Mester, 2003). Emrouznejad and Yang (2018) further revealed an exponential increase in the number of publications on productivity studies over the past four decades. On the other hand, the Islamic banking-specific arguments are primarily concerned with the differences between the business models of IBs and CBs due to Sharia constraints, which can affect their cost, profit, risk, and productivity profiles (Beck et al., 2013; Bitar et al., 2020). Two key distinctive features of IBs’ business models are finance for the real economy and risk-sharing between capital-providers and capital-users. IBs’ modes of financing, such as Murabaha (sales contract / cost plus financing contract), Ijarah (leasing contract), and Istisnā (manufacturing contract), are more connected to the real economy, as all transactions and financial instruments must be real asset-linked. According to Sharia principles, IBs are prohibited from engaging in leveraged (and speculative) transactions with weak or no links to real economic activities. Moreover, IBs do not invest in toxic assets and mortgage-backed securities, which were the primary causes of the GFC of 2007-2008 (Chapra, 2008, 2011). As to the risk-sharing aspect, some Islamic banking contracts, such as Musharakah (partnerships) and Muḍārabah (Trustee finance), are based on risk-sharing between fund-providers and fund-users, in contrast to the conventional banking system where depositors transfer the risk to the bank, which guarantees a pre-specified rate of return for their investments.
Key Terms in this Chapter
Theoretical Foundations: The underlying theories and principles that support the methodologies and analyses used in a study. In the context of this chapter, it refers to the economic and financial theories underpinning the assessment of banking productivity.
Productivity: In the context of banks, productivity refers to the efficiency and effectiveness with which they convert inputs (like capital, labor) into outputs (like loans, financial services).
Literature Survey: A comprehensive review of scholarly articles, books, and other academic publications. In this context, it refers to the systematic examination of literature concerning the productivity of Islamic Banks.
Data Envelopment Analysis (DEA): A nonparametric method in operations research used for efficiency measurement. It evaluates the performance of decision-making units (such as banks) by comparing their input and output data.
Banking Efficiency: A measure of how effectively a bank uses its resources to generate income and provide services. In the context of Islamic Banks, it often involves assessing how well these institutions balance profit-making with adherence to Islamic financial principles.
Evaluation Approaches: The methods and criteria used to assess and interpret the results obtained from DEA and other productivity measurement methodologies in the context of Islamic Banks.
Malmquist Productivity Indices (MPIs): A method for calculating productivity change over time, often used in conjunction with DEA. It measures the shift in the production frontier and the change in relative efficiency of decision-making units.
Islamic Banks (IBs): Financial institutions that operate in accordance with the principles of Islamic law (Sharia). This includes the prohibition of interest (riba) and the assurance that investments adhere to Islamic ethical standards.
Productivity Measurement Methodologies: The various approaches and techniques used to evaluate and quantify productivity. In the context of DEA, this refers to the specific methods applied to measure the productivity of Islamic Banks.
Variables For DEA Model Specification: The specific input and output variables chosen to define the DEA model in a study. These variables are critical in accurately measuring the efficiency and productivity of the decision-making units under consideration.