Efficiency of Islamic and Conventional Banks in Pakistan: A Non-parametric Approach

The purpose of this paper is to analyze comparative efficiency of banking system in Pakistan comprising of Islamic banks (IB), conventional banks with Islamic banking division (IBD) and conventional banks (CB). For this purpose we use two methods: First, ratio analysis to analyze cost, revenue and profit efficiency; Second, data envelopment analysis (DEA), for comparative analysis of banks’ technical, pure technical and scale efficiencies. We use efficiency scores of DEA to analyze the impact of size on the efficiency. Finally, we compare and contrast the efficiency estimates with the traditional measures of banks efficiency. We find that Islamic bank is more cost efficient and less revenue efficient. Considering their growth rate which is rudiment to scale efficiency (SE) we argue that Islamic banks should be encouraged to reach the efficient frontier in the banking industry by reducing their wastes. We further observe that hybrid banking may not be feasible form for banking industry in Pakistan. In view of the observed inverse relationship of size with scale efficiency we recommend reconsideration of the regulators’ policy of increasing the capital base of the banks thus forcing them to increase their size.