Measuring Efficiency of Islamic Banks in Bangladesh: An Application of Data Envelopment Analysis
Measuring Efficiency of Islamic Banks in Bangladesh: An Application of Data Envelopment Analysis
Measuring Efficiency of Islamic Banks in Bangladesh: An Application of Data Envelopment Analysis
ABSTRACT
This paper investigates the technical, pure technical and scale efficiency of the Islamic
banks operating in Bangladesh applying a non-parametric, Data Envelopment Analysis
(DEA) method. Data were collected from the annual reports of the respective banks, and
DEA-solver software was used to analyze the data in two different phases considering
different input-output variables. Analysis in the first phase revealed that technical efficiency
of all the Islamic banks was very high which amounting to an average of 98 percent, 96
percent, 98 percent and 96 percent in 2010, 2011, 2012, and 2013 respectively. Analysis
in the second phase revealed that the inclusion of some new variables changed the result
completely. Including some more variables in the analysis of efficiency measurement
process, it was found that all the Islamic banks were technically efficient in all the period
of the study; except in 2012 SIBL, AAIBL, and ICB Islamic banks which were technically
inefficient. Finally, this study came up with some recommendations to enhance the technical
efficiency of inefficient banks. Nevertheless, the results of the study are constrained by the
lacking of adequate literature in this field of study and robustness of the analysis.
Keywords: DEA, Technical Efficiency, Pure Technical and Scale Efficiency.
1. INTRODUCTION
Any bank, established and operated with the objective to implement and materialize the economic
and financial principles of Islamic Shari’ah in the arena of banking is called Islamic bank. The system
is based on the Islamic legal concepts of Shirkah (partnership) and Mudaraba (profit sharing). At
first, in March 1983, the long drawn struggle to establish an Islamic bank in Bangladesh becomes a
reality and Islami Bank Bangladesh Limited (IBBL) was established. Since then, eight full-fledged
private Islamic banks and approximately 30 Islamic banking branches of conventional banks have
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been established. At present, IBBL has gained first position in terms of profits, deposits, investment,
export , import and remittance collection among the 56 listed commercial banks operating in the
country. According to the Bangladesh Bank (BB), the deposits of the Islamic banking systems are
now 25 percent of all private banks deposits and its investments are 30 percent. In reality, Islamic
banking is a worldwide phenomenon involving a variety of institutions and instruments. In the
last few decades, Islamic institutions and instruments have been developed in many countries.
Gradually, Islamic banks are expanding all over the world. However, efficiency has always been
critical to the enhancement of the output of an organization. This study is designed to determine
the technical, pure technical, and scale efficiency of seven Islamic banks currently operating in
Bangladesh for the period of 2009-2013 based on DEA approach. The key advantages of DEA over
other approaches are that it accommodates more easily both multiple inputs and multiple outputs
and is able to measure efficiency. Research undertaken by the previous scholars was given the
inspiration to take up the study to analyze the efficiency of Islamic banks using DEA.
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Manarat International University Studies, 4(1), 2015
banks have been experiencing economies of scale due to being at less than the optimum size, or
diseconomies of scale due to being at more than the optimum size. Thus, decreasing or increasing
the scale of production could result in cost savings or efficiencies. The empirical findings seem
to suggest that Exim bank has exhibited maximum profit efficiency level. Abduh, Hasan, and
Pananjung (2013) investigated the efficiency and performance of Islamic Banks in Bangladesh
applying DEA and ratio analysis. This study concludes that SJIBL is better than other Islamic banks
in terms of its ROA, ROE, ETA, CAR, IER and AU ratios. On the other hand, with regard to banks’
efficiency, all Islamic banks have shown an improvement on their efficiency level. Hoque and
Rayhan (2012) explained that under the VRS output results Exim bank and SIBL are technically
efficient. Other banks are technically inefficient as their efficiency scores are less than one. Bhuia,
Baten, Kamil, and Deb (2012) examined online bank efficiency in Bangladesh applying DEA
approach. They considered deposits, capital and labor as input variables and advance, investment
and profit are defined as output variables. This study revealed that the most efficient banks were
AAIBL and SJIBL.
Rahman (2011) examined the branch-wise technical, pure technical, scale and allocative
efficiencies of IBBL using panel data and DEA approach for the year 2003 to 2007. The average
allocative efficiency is 61-76%, whereas the average technical efficiency is about 51-65% during
the study period. This means that the dominant source of inefficiency is due to both technical
inefficiency and allocative inefficiency but technical inefficiency has more contribution to
inefficiency than allocative inefficiency. These results are consistent with the fact that the Islamic
banks do not operate in an overall regulatory supportive environment. They are not even technically
sound enough in their operations. Average scale efficiency is about 53%, and average pure technical
efficiency is about 68%, suggesting that the major source of the total technical inefficiency for
IBBL branches are not pure technical inefficiency (input related) but scale inefficiency (output
related). Study results indicate that there has been moderate increase in productivity growth over
the years. Productivity increases in IBBL branches are mainly driven by technological change
(opening up and penetrating in other markets) not technical efficiency change (efforts of inefficient
banks to catch up with the efficient ones). The results show that the larger branch size is associated
with the higher efficiency. These results indirectly support the economies of scale arguments in
IBBL branches.
Using DEA approach, Rahman (2010) explained that Islamic banks as a whole is the
least efficient, while IBBL alone is slightly more efficient. He also showed that Islamic banks in
Bangladesh are improving and converging to a high level of efficiency. Study also found that the
Bangladeshi Islamic banking industry, especially IBBL, has in terms of assets, deposits, income
and financing base, grown rapidly over the study period 2002 to 2007. Finally, he suggested Islamic
banks to redirect their marketing and communication strategies to focus more on targeting floating
customers.
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Measuring Efficiency of Islamic Banks in Bangladesh...
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Manarat International University Studies, 4(1), 2015
Here, i = 1, 2, 3…………. I
Here, k = 1, 2, 3……….... K
Here, j = 1, 2, 3…………..N
Where there are N organizations in the sample producing I different outputs (yin denotes
the observed amount of output i for organization n) and using K different inputs (xkn denotes
the observed amount of input k for organization n). The wj are weights applied across the N
organizations. When the nth linear program is solved, these weights allow the most efficient method
of producing organization n’s outputs to be determined.
Where wj=Weight of the jth DMU, xij = Value of the ith input variables for jth DMU, yrj
= Value of the rth output variables for jth DMU, xit = Value of ith input variable for tth DMU. m =
Number of inputs, s = Number of outputs, n = Number of DMUs and θ = the value that signifies
the efficiency of the DMU. The j=l equation is a convexity constraint, which specifies the VRS
framework (Mostafa, 2010). Without this convexity constraint, the BCC model will be a CCR
model describing a CRS situation.
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Measuring Efficiency of Islamic Banks in Bangladesh...
If the scale efficiency is less than 1, the DMU will be operating either at decreasing returns
to scale (DRS), then a proportional increase of all input levels produces a less-than-proportional
increase in output levels or increasing return to scale (IRS) at the converse case.
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Manarat International University Studies, 4(1), 2015
Figure – 02: Technical Efficiency of respective banks under first phase analysis.
Figure - 2 shows DMU wise average TE score of first phase DEA analysis where IBBL was the
best performer with 100% TE, followed by FSIBL with 98% TE, jointly followed by AAIBL and
SJIBL with 96% TE, followed by SIBL with 91% TE, followed by EXIM bank with 88% TE,
followed by ICBIBL with 84% TE for the study period 2010-2013.
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Measuring Efficiency of Islamic Banks in Bangladesh...
Figure – 03: Technical Efficiency of respective banks under second phase analysis.
Figure-3 presents result of DEA analysis in the second phase, which reveals that inclusion of some
new variables change the result completely. If deposit, total assets, number of employees, profit
paid on deposits, and operating expenses considered as the input variables; on the other hand
investments, investment income, and operating income considered as the output variables, then
DEA reveals that all the DMUs are technically efficient in all the periods of the study except in
2012 SIBL, AAIBL, and ICBIBL were technically inefficient.
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Manarat International University Studies, 4(1), 2015
efficient frontier only from the PTE, means efficient under VRS but very far from the efficient
frontier regarding TE and SE. SJIBL, AAIBL and FSIBL are close to efficient frontier regarding
TE, PTE and SE. On the other hand, SIBL and EXIM bank are very far from the efficient frontier
regarding TE, PTE and SE.
5. RECOMMENDATIONS
Based on the findings of the study, researcher provides following suggestions to the different
stakeholder of banking sector of Bangladesh.
SIBL and ICBIBL operate at IRS, therefore these banks should invest more on input to
improve output, which will lead closure to the efficient frontier.
As IBBL and FSIBL operate at CRS, therefore these banks should sustain existing level of
investment on input to withstand current output, which is to the efficient frontier.
EXIM bank operates at DRS, therefore it should reduce invest on input to improve
efficiency, which will lead closure to the efficient frontier.
SIBL, AAIBL, and ICB Islamic banks must have to emphasis on efficient utilization of
input and output variables in order to remove their present unstable efficiency and ensure
stable efficiency.
Conventional banks can convert their traditional banking mechanism into Islamic banking
mechanism as this mechanism is permitted by Islamic Shariah and has proved high
efficiency in the utilization of input-output variables.
Bangladesh Bank, central bank of the country can encourage conventional banks to
implement full-fledged Islamic banking due to higher efficiency of this type of banking.
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Measuring Efficiency of Islamic Banks in Bangladesh...
6. CONCLUSION
The forgoing analysis reveals that outstanding result that all the Islamic banks are highly efficient
regarding utilization of inputs and their outputs. Analysis in the first phase reveals that technical
efficiency of all the Islamic banks is very high which are on an average 98 percent, 96 percent, 98
percent and 96 percent in the year 2010, 2011, 2012, and 2013 respectively. Analysis in the second
phase reveals that inclusion of some new variables change the result completely. Including some
more variables in the analysis of efficiency measurement process, study finds that all the Islamic
banks are technically efficient in all the period of the study except in 2012 SIBL, AAIBL, and ICB
Islamic banks which were technically inefficient. Therefore, it can be concluded that the AAIBL
and ICB Islamic banks have to be more careful in utilization of input and output variables in order
to improve technical efficiency. IBBL can be taken as reference or base by the other banks to adjust
their input and output variables to improve their efficiency.
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APPENDICES
Table # 3: PTE Scores, SE Scores & RTS for the first phase analysis.
DMU Input-Oriented VRS: Pure DMU Wise Scale Efficiency (SE) DMU Wise
Name Technical Efficiency (PTE) Mean = TE ÷ PTE Mean of SE
2010 2011 2012 2013 of PTE 2010 2011 2012 2013
IBBL 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
EXIM 0.95 1.00 0.90 1.00 0.96 0.84 0.87 0.99 0.94 0.91
SIBL 1.00 0.79 0.96 0.97 0.93 1.00 0.99 0.95 0.99 0.98
FSIBL 1.00 1.00 0.93 1.00 0.98 1.00 1.00 0.98 1.00 0.99
AAIBL 1.00 1.00 0.96 1.00 0.99 0.90 1.00 0.98 1.00 0.97
SJIBL 1.00 1.00 1.00 0.91 0.98 1.00 0.93 1.00 1.00 0.98
ICBIBL 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.39 0.98 0.84
Year wise 0.99 0.97 0.96 0.98 0.98 0.96 0.97 0.90 0.99 0.96
Mean
Source: Author’s calculation using DEA software.
Table – 4: Technical Efficiency Scores & RTS for the second phase analysis.
DMU Input-Oriented CRS: Technical Efficiency
Name 2010 RTS 2011 RTS 2012 RTS 2013 RTS
IBBL 1 Constant 1 Constant 1.000 Constant 1 Constant
EXIM 1 Constant 1 Constant 1.000 Constant 1 Constant
SIBL 1 Constant 1 Constant 0.999 Increasing 1 Constant
FSIBL 1 Constant 1 Constant 1.000 Constant 1 Constant
AAIBL 1 Constant 1 Constant 0.987 Increasing 1 Constant
SJIBL 1 Constant 1 Constant 1.000 Constant 1 Constant
ICBIBL 1 Constant 1 Constant 0.939 Increasing 1 Constant
Source: Author’s calculation using DEA software.
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Manarat International University Studies, 4(1), 2015
Table-05: Data sets of input-output variable of respective banks. (All figures are in BDT
and in million except no. of branch and no. of staff)
Input Variables Output Variables
Profit No. Opera
DMUs Total Operating Branch Invest Investment
Deposit Paid on of ting
Assets Expense No. ments Income
Deposit Staff Income
IBBL 291,937 330,785 14,472 6,087 251 10,349 275,196 24,766 15,657
EXIM 94,949 113,071 6,020 1,810 59 1,686 98,889 9,606 7,704
SIBL 44,850 55,169 5,436 1,328 64 1,252 39,730 3,886 4,515
2010
FSIBL 109,906 129,733 10,310 1,793 100 2090 101,218 13,340 3,735
AAIBL 119,380 146,335 9,576 2,119 100 2,110 106,765 14,119 6,523
SJIBL 102,177 132,823 11,170 1,822 84 1,881 101,347 15,242 6,269
ICBIBL 12,381 15,119 414 581 33 688 11,220 906 646
IBBL 472,122 549,979 30,900 11,065 286 12,980 472,704 48,145 25,346
EXIM 165,392 195,542 15,423 3,331 80 2229 156,446 20,476 8,284
SIBL 102,104 126,617 9,707 2,578 94 1802 94,461 13,629 5,503
2013
FSIBL 139,521 161,823 14,598 2,384 117 2367 121,597 18,278 4,410
AAIBL 141,705 170,936 12,052 2,548 110 2,387 127,827 16,989 6,763
SJIBL 96,481 121,963 10,578 2,338 92 2,173 85,707 13,615 5,031
ICBIBL 11,970 14,303 423 584 33 656 9,999 642 324
Source: Annual reports and websites of the respective banks.
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