How large are productivity differences between Islamic and Conventional Banks?

Despite the enormous growth in Islamic banking over the last thirty years, most studies, using DEA/stochastic frontier analysis, have found Islamic banks are either as productive or less productive than conventional banks. We take advantage of recent improvements in the direct estimation of production functions by Olley-Pakes and Ackerberg-Caves-Frazer (ACF) to develop fresh evidence on this question. Production functions are estimated and productivity calculated for conventional and Islamic banks in Bahrain and Malaysia between 1990 and 2011. We find that although in many respects the different techniques yield similar results, the ACF results are more plausible. Islamic banks in both countries tend to be around 50% as effcient as conventional banks though productivity growth is faster for Islamic banks. However, in Malaysia, a new set of banks, which we refer to as mixed banks, offering both conventional and Islamic banking, outperform conventional and Islamic banks in levels and growth. In Malaysia, at least, this new institution seems a promising way to meet the increasing demand for Islamic banking services.