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Although Islamic financial institutions are in existence since 1970’s, but studies

available on performance of Islamic banks were very few in the decade of

90’s.Many researcher came up with topic of performance of Islamic banks and its
comparison with the conventional banks in this decade mainly because, Islamic
banking has established its ground in Islamic world and data was available to
carry on the empirical research.
Samad & Hasan (1999) conducted an exploratory study to measure the
performance of Islamic banks in Malaysia. Their study assess inter temporal and
inter bank performance of Islamic bank (Bank Islam Malaysia Berhad (BIMB) in
profitability, liquidity, risk and solvency; and community involvement for the
period 1984-1997. Financial ratios are applied in measuring these performances.
Their study indicated that lack of knowledgeable bankers in selecting, evaluating
and managing profitable project is a main cause of slow growth of loans under
profit sharing.
Sarkar (1999) indicated that Islamic banks can survive even within a
conventional banking framework by which over from PLS to trade related modes
of financing wile studying performance problems and prospects of Islamic
banking system of Bangladesh.
Iqbal .M (2001) evaluated & compared the performance of Islamic banks with the
conventional banks covering a period of 1990-1998 using a sample of 12 Islamic
and conventional banks of Islamic world. They employed trend and ratio analysis
for the measurement of performance and found that Islamic banks perform fairly
well in the period under study and outperformed the conventional banks with
certain limitations however, his study was among the one of the initial empirical
studies on comparison of Islamic and conventional banking so they established
benchmarks for future studies but their results should be taken as indicative rather
than conclusive.

Bashir (2003) studied the determinant s of profitability of Islamic banks of

Middle Eastern countries using bank level data between 1993 and 1998.
Controlling for macroeconomic environment, financial market structure, and
taxation, their results signify that high capital-to-asset and loan-to-asset ratios
lead to higher profitability. Bashir (1999) and Bashir (2001) performed regression
analyses to determine the underlying determinants of Islamic bank performance.
He concluded that performance of banks, in terms of profits, is mostly generated
from overhead, customer short term funding, and non-interest earning assets
Mohamad, Hasan &Badar ( ) measured and compared the cost and profit
efficiency of 80 banks in 21 of Organisation of Islamic Conference (OIC)
countries: comprising of 37 conventional banks and 43 Islamic banks, using the
Stochastic Frontier Approach (SFA). Their findings suggest that there are no
significant differences between the overall efficiency results of conventional
versus Islamic banks. However, there is substantial room for improvement in cost
minimization and profit maximisation in both banking systems. Furthermore, the
findings show no significance difference in average efficiency scores between big
versus small and new versus old banks in both banking streams.
Hussein (2003) provides an analysis of the cost efficiency features of Islamic
banks in Sudan between 1990 and 2000, using the stochastic cost frontier
approach. . His results show large variations in the cost efficiency of Sudanese
banks with the foreign owned banks being the most efficient. State owned banks
were the most cost inefficient. He extended the analysis to examine the
determinants of bank efficiency and found that smaller banks are more efficient
than their larger counterparts.
Yudistira (2004) evaluates the stability and efficiency of 18 Islamic banks using
non parametric technique, Data envelopment analysis. His findings suggest that
inefficiencies in Islamic banks is quite low as compared to the conventional
counter parts even in the year of crisis. He also suggested that to eradicate the
diseconomies mergers should be encouraged.
Hasan (2004) reviewed the literature on the performance of Islamic banks, he
examined & critiqued the criteria and methodologies employed to measure the
performance of Islamic banks and suggested that Islamic bank’s performance
should be measured in context of Islamic principles and in the frame work of
social responsibility not on the basis of established principal of cost minimization
s this is not the ultimate objective of an Islamic bank.
Hassan (2005) examined the relative cost, profit, X-efficiency, and productivity
of the world Islamic banking industry. Employing a panel of banks during 1993-
2001, he used both the parametric (Stochastic Frontier Approach) and non-
parametric (Data Envelopment Analysis) techniques as tools to examine the
efficiency of the sample banks. He calculated five DEA efficiency measures
namely cost, allocative, technical, pure technical, and scale and further correlated
the scores with the conventional accounting measures of bank performance. He
found that the Islamic banks are more profit efficient; He also found that the main
source of inefficiency is allocative rather than technical. Similarly, his results
suggest that the overall inefficiency was output related. The results suggest that,
on average the Islamic banking industry is relatively less efficient compared to
their conventional counterparts in other parts of the world. The results also show
that all five efficiency measures are highly correlated with ROA and ROE,
suggesting that these efficiency measures can be used concurrently with the
conventional accounting ratios in determining Islamic bank performance
Ismail and Pratomo (2006) attempted to prove the agency cost hypothesis of
Islamic Banks in Malaysia, under which high leverage firm tends to reduce
agency costs. They set the profit efficiency of a bank as an indicator of reducing
agency cost and the ratio equity of a bank as an indicator of leverage. Their
findings were consistent with the agency hypothesis that higher leverage or a
lower equity capital ratio is associated with higher profit efficiency.
Mokhtar et al (2006) empirically investigated the technical and cost efficiencies
of Malaysian Islamic banks using stochastic frontier approach. And found the
increase in the efficiencies of Islamic banks on average during the period of study
i.e, 1997-2003.his study also proves that full fledge Islamic banks are more
efficient than Islamic windows of conventional banks.
Sufian (2007) estimated the efficiency of Malaysian banks using data
envelopment analysis, he analysed the impact of risk using problem loans as
input variable and it has a mixed impact on Malaysian banks efficiency. They
investigated that technical efficiency is more sensitive to exclusion of risk
factors. They found out that scale inefficiency dominates technical inefficiency
and also that foreign banks are more efficient than local banks.
Kamaruddin et al (2008) presented 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
Jhones (2010) estimated the efficiency of Islamic and conventional banks of GCC
region using both DEA and financial ratio analysis and compared the results of
both methods. From the FRA, Islamic banks are less cost efficient but more
revenue and profit efficient than conventional banks. From the DEA, average
efficiency is significantly lower in Islamic than conventional banks. A
decomposition method new to the banking context shows that the efficiency
difference is more a consequence operating under Islamic rules than of
managerial in-adequacies. Productivity growth has been slight, and is caused
mainly by Positive technology change.

No published research paper is available on the performance of Islamic banks of

Pakistan neither on the performance comparison of Islamic and conventional
banks. But few studies are available on the efficiency of commercial banks in
Akhtar (2002) performed the X- efficiency analysis of commercial banks on
Pakistan using DEA model. The overall efficiency score of Pakistani banks was
found to be 0.80 in the year 1998. The technical efficiency, reflecting the
productivity of inputs, of Pakistani banks is found to be lower than the allocative
one It proposed the fact that banks in Pakistan need to improve their inputs
productivity e.g. deposits and capital.
Burki and Niazi (2006) studied the impact of financial reforms on Pakistani
commercial banks, they used DEA model to estimate the efficient frontier. They
computed cost, allocative, technical and scale inefficiencies. They also studied
the impact of banks size, interest income to earning asset, loan to deposit ration
on banks efficiency, they used Tobit model and found positive impact of all these
variables on banks efficiency scores.

Weighted sum of outputs

Efficiency = ─────────────
Weighted sum of inputs