The efficiency of Islamic and conventional commercial banks in Malaysia

Purpose - The purpose of this study is to examine the relative efficiency of the Islamic commercial banks (ICBs) and conventional commercial banks (CCBs) in Malaysia. The study measures and compares the level of efficiency of both ICBs and CCBs from the year 2003 to 2007. Design/methodology/approach - There are ten local commercial banks selected in Malaysia, which comprise of eight CCBs and two ICBs. The study uses data envelopment analysis (DEA) to measure the relative efficiency of the selected banks in intermediating inputs into outputs. The study then analyses the difference in the average efficiency score of the ICBs and CCBs using the Mann‐WhitneyUtest. Findings - This study found that the CCBs outperformed ICBs in all efficiency measures. The finding indicates that the CCBs may be more efficient than the ICBs due to managerial efficiency and technological advancement. Research limitations/implications - This study may be extended in various ways. Since, this study only covers a sample period of five years, i.e. 2003 to 2007, future research might cover more sample periods. Further studies could also take a bigger sample size by including both the domestic and foreign commercial banks. Practical implications - The study indicates that the domestic commercial banks' management is well organised, reflecting the effective roles of a bank as the mediator between the savers and entrepreneurs. The technology used in the commercial banks may be up‐to‐date and fully utilised in the bank's operation. However, the commercial banks in Malaysia are facing the scale inefficiency. This means that the banks are unable to fully utilise their capabilities and capacities in generating the outputs from their resources. The findings also indicate that the scale inefficiency is the main factor that leads to the low technical efficiency in the ICBs as their size is relatively smaller than the CCBs. Originality/value - This study identified the most and least efficient domestic banks and the finding could be useful to the regulators and the banks to identify the bank's ranking within the industry. Thus, it is hoped that the regulators are able to address the gap between the best and worst‐practices. The study may also improve the awareness among the least efficient banks to initiate the proactive measures in order to be sustainable in the industry.