ISLAMIC VS CONVENTIONAL BANK EFFICIENCY IN MENA: A STOCHASTIC DISTANCE FUNCTION WITH BAD OUTPUTS

Abstract

According to a recent study, efficiency of Islamic and conventional banks in the MENA (Middle East and North Africa) region is drawing the attention of researchers as the financial system of this region consists of conventional banks and Sharia compliant banks or Islamic banks. This study aims to assess Islamic banks’ efficiency in MENA relative to conventional banks through possibly a stochastic distance function approach with bad outputs. This paper evaluates the operational performance of banks more comprehensively because it also considers undesirable outputs like non-performing loans (NPLs). The data used for this study is from 2000–2020. From MENA bank behaviors are studied.  Estimates show that Islamic banks, on average, are similar or more efficient as compared to conventional banks, especially when undesirable output is considered. This paper contributes to the MENA bank efficiency literature by identifying that Sharia-compliance institutions face different operational challenges and are not necessarily less efficient than their non-compliant counterparts. At the end, policymakers and investors should create regulatory frameworks for financial regulators that should consider regulatory objectives, and not just economic ones, but social objectives too.

Keywords: Islamic Banks, Conventional Banks, Efficiency, MENA, Stochastic Distance Function, Bad Outputs, Non-performing Loans