The efficiency of Islamic and conventional banks in the Gulf Cooperation Council (GCC) countries: An analysis using financial ratios and data envelopment analysis

The purpose of this paper is to provide an in-depth analysis, using both financial ratio analysis and data envelopment analysis (DEA), of a consistent sample of Islamic and conventional banks located in the GCC region over the period 2004 to 2007. Results from the financial ratio analysis indicate that Islamic banks are less cost efficient but more revenue and profit efficient than conventional banks. Differences in performance between Islamic and conventional banks are significant in the case of four of the six ratios. The DEA results indicate that gross efficiency (i.e. the efficiency of each bank relative to the whole banking sector) is significantly higher, on average, amongst conventional compared to Islamic banks. Gross efficiency is decomposed into a component which reflects managerial inadequacies and a component which is a consequence of the constraints caused by bank type. When equity is included as an input into the DEA model (to reflect risk-taking attitudes of banks), there is evidence that the difference in gross performance is more a consequence of the latter than the former since net efficiency (which takes out the inefficiency caused by bank type) is not significantly different, on average, between the two groups. When equity is excluded from the model, however, the inferior performance by Islamic banks is caused by a mix of managerial inefficiency and the rules under which Islamic banks operate. A comparison of the rankings of banks based on DEA efficiencies and financial ratios finds a consistently significant positive relationship only in the case of the gross DEA efficiency scores and the cost ratios. The DEA and financial ratio measures (particularly the revenue and profit ratios) therefore offer different information, and the methods are complements rather than substitutes. Finally, productivity has grown only slightly over the four-year period. This is caused by a fall in efficiency combined with an increase in technology. The magnitude of the components of productivity change is particul