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ISLAMIC BANKING

Efficiency in Islamic Banking during a FinancialCrisis-an Empirical Analysis of Forty-Seven Banks

Abstract

This writing will present an analysis of Islamic banking during the financial crisis of the late 2000’s. It will be an in depth look at this question by measuring efficiency by way of the on-parametric technique of DEA, Data Envelopment Analysis . The present paper explores this question further, suggesting that the Islamic banks displayed an efficiency increase during 2006 through 2009, especially the larger banks. Small and medium size banks, however, came from a beginning of a much less efficiency. The results of this study also demonstrate that the Islamic banks’ efficiency seems to increase during an economic crisis, whether operating in Middle Eastern or non-Middle Eastern Countries.

1 Introduction

In the 1970’s the first Islamic banking appeared—the Dubai Islamic Bank (DIB). Following that, the International Islamic Development Bank (IDB) was established in Jeddah, Saudi Arabia. After that both private and semi-private Islamic banks were established in various countries such as Bahrain, Kuwait and Egypt. Coinciding with that in the early 2000’s, Islamic banking was spreading in other Islamic countries. Iran, Bangladesh and Pakistan gained Islamic banks in 2005. During that time, the bank in Iran was forced to establish minimum and maximum rates of returns for various industries. The reason for this was that Islamic banks could then have the money for their own operations and also make a profit. This was possible even while observing the Shariah rule of charging no interest.

Profit and loss in Islamic banking can be shared by several different methods. One is to establish a partnership, called Musharaka. This is the sharing of investments while still not being involved in the management of a company. Another method is Mudrabah, which is making a provit by re-selling or leasing a contract with a profit (jiara). In Western banks this is done by a profit but in Islamic banking would be done by reselling at a higher price.

This type of banking is in reality a more stable system because banks tend to diversify the investments, which in turn, makes the risks much less, and the profits more. In turn, this tends to bring in more investors and again, increases the bank’s efficiency. The Shariah practice in banking involves four distinct laws of business.

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First of all is the rule of the lender and the borrower shares in the profit or loss. Second is fixed charges established ahead of time. Third is charging no interest. And the Fourth rule is the lender and borrower collaborating in the transaction. Concerning profit and loss sharing, it involves two basic principles. Mudrabah, one of the principles, is the agreement between two groups. In banking, the two groups would be the group that provides the funds and the other would be the companies obtaining the funds. If a profit is made by the company, the two groups would share the profit, which would be agreed upon beforehand. If the business operated at a loss, the bank would have to “eat” the entire loss. While this does not seem fair, the business would have exerted time and effort and resources to try to make the business work successfully. In Western banks, this business arrangement would be similar to a venture where one group (bank) would provide funds and the other group (business) would provide the operation and business knowledge.

As was discussed previously, Musharaka is the second rule, which is a type of partnership between two groups or two parties. When applied to Islanic banking, the bank provides the money and the business uses the money to operate the business of course. But, if there is a profit, they both split the profit, and also split the loss if there is one. In Western banking, this would be considered a “joint venture” where profit or loss would also be borne by both parties to the agreement, which was decided upon prior to the venture. Another principle of Islamic banking is “set” bank fees as opposed to charging interest. It is called Murabaha in Arabic, and is self explanatory. It is the adding of charges on to the cost of the goods or services in the transaction or business. It is a contract in which the cost of the desired products are discussed and set charges assessed by the provider of the financing, which in this discussion, is the bank. Murabaha is a type of transaction that could be compared to a “rent to own” type contract arrangement in Western banks. A deferred payment sale without extra fees or charges is called Bai-Mua’ jjal. In the “Western” banking this would be similar to a “90 days same as cash” or any other type of deferred payment sale with no money down. Leasing is the contract called Ijara, which is when the owner of the products allows their use by other parties. The Western “lease with option to buy” is a similar concept.

The same concept of no charges is the Qurad. This is when the borrower gives the financier the principle without any other charges. There are other categories as well, all of them having similar principles in Western banking. There are trusteeships (Wadiah) and pledges (Rhan) both of which are like types of savings accounts. Islamic banks follow the principle of Mudaraba when it comes to savings and investment products. The person or company that makes the money deposit does not know how much the money will make except the ratio of profit sharing upon which has been agreed to previously. Of course, repayment is only made to the Islamic bank when there is a profit.

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The bank uses two things in order to apply the profit/loss rule. The first would be the Musharaka, where both the bank and business agree on a specific division of profit. Some of the banks investments are high risk matters so being careful about such ventures is very important. Islamic banks must find business schemes that are much less risky. They are constantly in competition with the Western style banks. Islamic law forbids interest because it would be bringing in money without any actual effort on the part of the bank. According to that law, income must be from an investment, physical labor, or such related activities but not just someone else using the money from a lender. In the Islamic banking industry then, both the bank and the investor or business owner share in the profit and loss, instead of the bank collecting interest whether or not the business is successful.

In the manner of the Islamic banks, they assess a set charge for the service they provide, which is the money of course and the processing of the loan itself. By charging this set price, they can recoup the cost of “doing business” from the charges, without charging interest. For the most part, Islamic banks get a higher percentage of profit that those that borrow from the bank since the banks are furnishing the money and therefore, more of the risk. In the long term loans, the funds must be kept ready to lend out until the end of the period of the contract. In Islamic bank, this makes a great exposure to high risk should this investment fall through. More recently, Islamic banks were growing consistently. The International Monetary Fund (IMF) reported in 2005 that the number of Islamic banks had grown from a previous 75 to approximately 300 in total. By 2007 the assets of the entire industry were about $250 billion and the rate of growth was reportedly a yearly 15%. That is triple what the growth rate was in the Western banking industry.

Parker & Arnold reported that the asset increase in Islamic banking was up to 40%. There were approximately 300 Islamic banks with a minimum of $500 billion in assets in the year 2007. Sharia Calling reported that Islamic Bank institutions have grown 29% during the year 2009. Also in 2009 the assets of those banks were said to be $882 billion. Little wrote that by the year 2015 the Islamic banks will have assets of close to $4 trillion US dollars. 2 Research Question and HypothesesDuring an economic crisis, are Islamic banks efficient and stable?H1: No differences in the efficiency of Islamic banks operation in Middle Eastern and non-Middle Eastern countries during an economic crisis. H1a: There are differences in the efficiency of Islamic banks operation in Middle Eastern and non-Middle Eastern countries during an economic crisis. H2: There are no differences in the efficiency of Islamic banks operation between small and large Islamic banks during an economic crisis.

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H2a: There are differences in the efficiency of small and large Islamic banksAre Islamic banks stable and efficient during a financial crisis? 3 Literature ReviewFew actual studies have been done concerning the efficiency of the Islamic banking system. Of course many studies have been done about the same thing in Western style banks. A profitability study was done by Samad and Hassan, who also studied liquidity, risk, and solvency. Their hypotheses were (1) that the liquidity ratio in Islamic banks would be increased during the opening stages of the banks’ operations and (2) the increase in assets of Islamic banks would depend on the general public’s knowledge about these banks and how they use tools to operate.

Two different time periods were studied—1984 to 1989 and 1990 to 1997—in order to compare the financial information. Accounting rations compared profits, liquidity, risk and solvency. Also measured was the banking institutions’ loyalty to the Islamic community. It showed that the studied institutions were more liquid than Western banks when it came to cash deposits. Islamic banks reported a cash deposit ratio of .02 compared to .01 for the Western style banks. Hassan pointed out that later in the development of the banks, there was a slightly greater risk, yet still was at less of a financial risk than Western style banks. A study by Yudistira looked at the efficiency of 18 Islamic banking institutions over the course of 3 years, from 1997 to 2000, and used the DEA to measure and compare the efficiency of the banks. He scored the banks between one and zero, using one as a completely efficient bank. That does not, however mean that a bank with a score of one has the most profits from a given input, but rather used as a mere scoring system. This particular study collected information from nonconsolidated income and financial statements obtained from the International Bank Credit Analysis, Ltd in London, England. The time studied was 1998 and 1999, a period of financial crisis globally. This information was all exhibited in U.S. dollars and in conjunction with the consumer price index (CPI) of each particular country to take into account economic changes. Three different inputs and outputs were studied. The inputs used for this study were the cost of staff, fixed assets, and the total deposits. The outputs were loans in total, miscellaneous income and the amount of liquid assets. Those banks analyzed were determined to be less efficient in the years of 1998 and 1999 than they were from 1997 to 2000. Yudistira also found that those banking institutions in the Middle East were much less efficient than those in the rest of the world. One important finding from Yudistira was that the Islamic banks were much more efficient than Western style banks, sometimes as much as 10% more efficient. In addition, the reason for the study conclusions was to show that the Islamic banks did very well during all periods of time, not just during a financial crisis. The data showed the importance, for the small and medium Islamic banks, of mergers and acquisitions. Finally, the Middle

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Eastern market was not determined to be significantly important in the study.

In the study by Samad, the performance of the Islamic banking system as compared to the Western system was compared in the country of Bahrain. Samad studied the information from six Islamic banks and 15 Western style banks from 1991 to 2001, a ten year study. Samad looked at bank statements and balance sheets using a set of ratios to determine each bank’s specific profitability, liquidity and credit-risk performance. In Samad’s research, it showed that no significant difference exist between the Western banking systems and the Islamic banking systems in the country of Bahrain in reference to profitability and deposit risk. The Islamic banks showed higher equity ratios than the conventional bans. It also showed that the Western style banks used less discretion in the loan decisions than did the Islamic banks. In addition the reason for the ratios was to show that Islamic banks usually have more liquidity than Western style banks, which would suggest that the Islamic banks had lower liquidity risk that the comparable banks.

Ariff et.al researched 80 banks. Of those, 43 were Islamic and the rest were Western style banks. The information in this study was gathered between the years 1990 and 2005, which was long enough to make a valid comparison. This showed the Islamic banking institutions fared during the 1990 financial crisis. The results also showed past indicators that could be utilized to predict future trends for both banking systems. The information was changed to U.S. dollars and also adjusted for inflation.

Arrif et al. made use of the DEA since there were no forms such as functional or distributional that were necessary. Efficiency equals the weighted total of the inputs was the was efficiency was measured in this study. It showed that Islamic banks and Western style banks were the same re efficiency in the use of resources proportional to their capacity to create profit. Management had control of their internal resources, but less influence re the external factors such as governmental rules and regulations. That same study suggested the conventional banks were less efficient that the small Islamic banks due to the capital structure of each. The other reason was that small Western style or conventional banks were up against more competition, which resulted in negative to their income. Moreover, this study pointed out the need for Islamic banks to be more attentive to how they use their resources to match the efficiency of the Western banks. The cost and profit efficiency of older Islamic banks was not as good as the older Western banks. The reason was determined to be that the Western style banks had more business experience and obtained it over a longer period of time.

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Ariff also wrote that the Islamic banks that were considered “newer” were much less efficient than the “older” banks. Older Western banks fared better with cost and revenue efficiency than the new Western banks. Ariff surmised that the relative size of the assets of the banks, plus the experience advantage, were the reasons behind the findings. Smaller sized Western style banks had a higher profit and cost efficiency than the large Western banks.. The researchers further found that both smaller and larger Islamic banks should watch their cost and profit efficiency in order to remain competitive.

Ariff et al. also looked at geography as a factor in banking efficiency. The report showed that Western banks had better performance in Africa. But, in Asia, Western style banks fell down in the area of profits compared to Islamic banks. Not surprisingly, Islamic banks did better with cost, revenue, and profits in the Middle Eastern countries.

Al-Tamimi researched into what might have had an effect on Islamic banking and Western style baking in the United Arab Emirates from 1996 through 2008. The study used the regression, ROE and ROA as variables, and the independent were Gross Domestic Product per capita, financial development indicators, concentration, cost, and the branches per bank. The reason for the results were to demonstrate that liquidity and concentration actually were the most important factors for the Western banks’ performance, while the cost and branches were the most important determinants for the Islamic banks’ performance.

A number of other researchers noted that those Islamic banks had the same risks as the non-Islamic banks. Ariffin, Archer, and Karim studied 28 Islamic banks in a number of different countries by questioning the risk management teams about the risks faced by those banks. This was compared to banks in the Western system. They used less technical risk measurement tolls than the Western banks.

According to Srairi due to a lack of experience and being less familiar with the financial tools available, Islamic banks assumed more risk than their Western counterparts. This resulted in Islamic banks needing more capital to take care of the risk. A study done by Johnes, Izzeldin, and Pappas was for the purpose of measuring the efficiency of Islamic banks in comparison to Western banks through the Cooperation Council of the Arab States. They used two tools to determine their results—the DEA, and the financial ratios analysis. Six banks in the GCC area provided information on their financials from 2004 to 2007. Western banks were more cost efficient, but less revenue and profit efficient than Islamic banks.

In the Islamic banks, the return on assets was on average, higher than the Western banks, because the Islamic banks had more invested in assets and not so much in debt contracts. The return on the equity was about the same in both style banks. There was a huge increase in the development in

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the Gulf area at that time. The purpose of the DEA analysis was to show that the Islamic banks showed a lower efficiency than the Western style banking system.

A study done by M.K. Hassan and Bashir involved information obtained from about 43 different Islamic banks between 1994 and 2001. The study used different variables to demonstrate the effect on the efficiency and profitability of those banks. It revealed that higher capital and “loan to asset” ratios led to higher profits. It also showed that there was a relationship between overhead and profit in the Islamic banks.

Initially the analysis of data was called FRA, the financial ration analysis. It was a simple way to compare banks in regard to cost, revenue and provit. The downside of FRA is that it did not include all the information needed for the complicated industry of banking. Regardless, the results of the study of this indicated that Islamic banking’s cost to income was higher that the Western banking system in comparison. Although the cost was higher in the Islamic banking system, it was because of having to pay the Shariah compliance board which made sure the banks were abiding by Islamic law. The study found that this requirement added costs through extra salaries, legal fees, and complicated financial products in order to remain in competition with Western banks. Srairi in his study utilized the stochastic frontier approach in order to evaluate the cost-profit efficiencies in 71 Western and Islamic banks between the years 1999 and 2007. These countries were those in the Gulf Cooperation Council countries. This study concluded that the Western banks were more efficient that the Islamic banks.

Another study done by Omar, Majid and Rulindo focused on private banks in Indonesia and their efficiency. Between 2002 and 2004, the study used the DEA to collect and analyze information from 21 different banks. Two were Islamic banks and 19 were Western banks. Their conclusion suggested that the Islamic banks had higher than average cost and profit efficiency compared to the Western banks. Sufiullah studied the performance of Islamic banks compared to Western banks by the use of financial ratios. Data was used from four Western banks and four Islamic banks during the years of 2004 to 2008. Sufiullah’s results were that Islamic banks had better performance ratios in the areas of business development, liquidity, profitability and solvency.

Alkassim compared the conventional or Western style banking system with the Islamic banking system, using 18 Western banks and 16 Islamic banks. He used regression analysis and eight different variables from 1997 to 2004. The regression analysis was applied to three variables: net interest margin, return on equity, and return on assets. The results suggested a positive relationship between profitability and the total assets re: Islamic banks, and a negative relationship between the same two criteria in the Western style, or conventional bank. In total, the equity and relationship to

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profitability was positive in the Islamic banking sector, but negative in the Western banking sector. Lastly the letting of loans showed a positive in both the Islamic and Western banks. The DEA was used by Al Khathlan and Malik to assess the efficiency of Saudi Islamic banks. They collected information from ten Islamic banks’ websites from 2003 to 2008 and the results were that an increase in efficiency was shown in managing financial resources. Kashani and Obay researched the productivity of United Arab Emirate banks’ statistics regarding efficiency and operations compared with GCC banks. They studied the years from 2000 to 2005, using the DEA as a model of the efficiency. Their sample consisted of 56 banks—41 Western style banks and 15 Islamic banks. The researchers demonstrated that the UAE banks were more efficient than the GCC banks. Management of the banks both Islamic and conventional (Western style) in the UAE demonstrated an increase in pure and technical efficiency, but fell off in scale efficiency. The reason for the study was to show that no real differences existed between the Islamic and Western style banks in the UAE. An investigation by Kamaruddin, Safa, and Mohd focused on profit and cost both in Islamic windows in Western banks but also Islamic banks on a whole. The DEA was used to determine cost and efficiency. Their particular study included 14 banks in Malaysia between the years 1998 and 2004. Twelve of the banks were just the windows in non—Islamic banks and two were Islamic banks. Financial ratios from the balance sheets and income information was used for the study.

Kamaruddin et al. researched the Islamic banks technical efficiency through items such as internet banking, smart cards, ATM’s and so on. The Islamic banks used about 30% of their resources. This was determined to be wasteful of resources. The reason for the student was also to demonstrate that the Islamic banks were two times more inefficient as Western style banks in Malaysia during this time. Islamic windows in conventional banks and Islamic banks in foreign countries, other than the Middle East operated more efficiently on the cost factor than the profit factor. It was a comparable riot to the Western style banking system.

Al-Jarrah and Molyneux studied the efficiency of banks in what may be considered Arabian countries with information collected in the years 1992 and 2000. The SFA was used as a measuring device. The Islamic banks turned out to be more efficient in several ways than the Western-style investment banks. In addition, the Islamic banks that were considered to have more assets were totally more efficient in profit and cost that the larger Western style banks.

The study by Sufian and Akbar was to evaluate the performance and efficiency of Islamic banks in 16 different countries in Asia, North Africa and the Middle East. This included 37 banks and the data was collected between 2001 and 2006. They used the DEA, and obtained results that showed a

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positive relationship between loan intensity, size, capitalization and efficiency. Their research was about the efficiency of Islamic banks in Malaysia between 2001 and 2005, using the DEA to analyze the data. There was an economic downturn in 2002 with a slight upturn in the following two years. Sufian opined that Western style banks were not as efficient as Islamic banks. In addition, the findings were that the size of the bank and market share had an adverse impact on Malaysian Islamic banking’s efficiency, and therefore, profit. Lastly, the managerial efficiency was higher in Western banks in the area of cost control. It apparently was much less so in Islamic banks studied.

Mokhtar, Abdullah, and Alhabshi studied Islamic bank’s efficiency, along with Islamic windows in Western banks and Western banks themselves in the country of Malaysia They got their information from the financial statements from the banks. The study included 20 Islamic windows, 2 Islamic banks and 20 Western style banks and the time period was from 1997 through 2003. The DEA model was used as a benchmark of the efficiency. The findings were that Islamic banks had more efficiency than just the Islamic windows, but Western style banks were more efficient overall. Hassan, Mohamad, and Bader did a study that was similar to other studies in that they investigated the efficiency of 40 banks, which included 18 Western style and 22 Islamic banks by using financial statements. This particular study used the SFA model and t tests as a measure of their efficiency. Their research showed that both banking systems (Islamic and Western style) was more profit efficient and lower cost efficiency. Čihák and Hesse sampled the efficiency of a large number of Islamic and Western style banks. It consisted of 520 analyses of 77 Islamic banks and 3248 for 397 commercial banks between 1993 and 2004. These researchers attempted to come up with the importance or non-importance of the size of the bank vis-à-vis the stability of the institutions of Islamic banks and commercial ones. In order to measure the efficiency, they used regression analysis. Their findings suggest that Islamic banks were not as efficient as the Western style banks but that the Islamic banks showed more stability when banking was smaller scaled. A study was done by M.K. Hassen regarding Islamic banking efficiency. The information in his study came from bank statements and balance statements of the banks in 21 different countries from 1995 through 2001. He used the approach of parametric and nonparametric to analyze this efficiency. The study included the measurement of allocation, cist and different types of efficiency was measured. The study suggested that Western style banks were more efficient in other parts of the world than were Islamic style banks.

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El Moussawi and Obeid studied the Islamic banks’ that were involved in the Gulf Cooperation Council (GCC) for the years of 2005 to 2008. They used the DEA model in the study of 23 Islamic banks and found that during that three year period, inefficiency of a technical nature went up by 14%.

Hamilton, Qasrawi, and Al-Jarrah researched Islamic and Jordanian Western banks’ efficiency. They did an analysis of the sampled banks according to the cost and profit for 1993 through 2006. The measurement used was the SFA. The reason was to show that Islamic banks had less efficiency than the Western style banks. The researchers showed higher efficiency in cost and profit by the Western style banks.

Shahid, Rehman, and Niazi also researched Islamic banks and Western style banks, but did so in the country of Pakistan. This particular research covered ten banks—five of each kind and for the time 2005 to 2009. They used the DEA model and also the t tests in their investigation and study of the efficiency of the banks. They found no appreciable difference in efficiency scores between the two types of banks. The relative efficiency of several banks was studied by Beck, Demirguc-Kunt and Merrouche in a very large sample involving over 140 countries and almost 3000 banks. Among those banks 99 were of the Islamic type and the rest were Western type. Information was gathered for the years 1995 to 2008. The analysis used were both ratios and regression. The reason for the results was to demonstrate no significant differences in the banks’ efficiency.

4 Efficiency Differences Based on Size

The next research studies show the efficiency of a bank as per its size. Darrat, Topuz and Yousef studied the banks in Kuwait, utilizing the DEA. The states and documents in eight banks were analyzed over the time period of 1994 through 1997, including information on labor, capital, and deposits. The outputs were investments and loans. The entire object was to show that approximately 47% of the banks’ resources were not being used appropriately to make a profit. Small banks were more efficient than large ones. Additionally there is a positive association between capitalilzation, profitability and efficiency in the Kuwaiti banking system. (Darrat)

Mostafa looked the 100 Arab banks utilizing the DEA system to study the efficiency in 2005. Size had a bearing on the efficiency. Only eight of the 100 banks were found to be efficient and those tended to be international, not local banks. The researcher recommended that the operations could be more efficient by reducing waste and adding to savings.

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Akhtar (2010) demonstrated the necessity of efficiency in the banks in Pakistan from 2001 to 2006, using the DEA system. The objective was to show that the banks in Pakistan had a lower efficiency rate due to administrative costs and high risk investing. The smaller banks offered less services than the Western style banks and it was suggested that the system could have better efficiency by using labor and capital in more advantageous ways. The following were recommended: (a) diversified investments to reduce risk andincrease return and (b) developing a merger/acquisition plan in order for the larger banks in order to adopt a more competitive stance. Al Shamsi, Aly, and El-Bassiouni studied the efficiency of theWestern banks located in United Arab Emirates, using the DEA to research the data. Inefficiencies were discovered to come from poor allocation of resources. .5 Methodology5.1 Research Design

The paper was designed as non-experimental. Experimental papers measure the influence of one variable on another, using treatment. Herzinger and Campbell said the experiemental deisgn determined causes between the particular variables. Quantitative design is non-experimental. (Belli) This paper does not use the experimental design because it does not comport with the reason for the paper. 5.2 Data Envelopment AnalysisThe DEA model was the instrument used to measure efficiency. The DEAis a linear programming system designed to show whether a specific decisionmakingunit (DMU), or bank, is efficient or not efficient. The DEA systemcreated a standard set by the efficient banks for comparison with inefficient peers.In this system, banks received scores of either 0 or 1.The banks that were found to be efficient got a score of one, which meant their output was optimal compare to the other sampled banks. Charnes et. al., based on constant return to scale (CRS), developed the DEA model. The intent was to make up a system that would generally model the single-input, single-outputs setting. Efficient banks had a score of one, meaning that they had optimal output levels in contrast to other banks in the sample.

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Along with another pair of researchers, Banker and Cooper, Charnes modified the DEA system to also take in the variable return to scale (VRS). Farrell used this for measuring efficiency: Efficiency=input/output. He also said that a bank could come up with several outputs and several inputs. His formula set up the standard for the best DMU re the less efficient banks by looking at several inputs and outputs.

Yudistira looked at the methods studied and used the N DMU’s in the banking institutions with all samples being called n, and the outputs by m. Thus, the banks’ efficiency with be computed with the equation:11, 1,..., , 1,...,mi isis nj jsj

u ye i m j nv x (1)i = outputj = inputis y = amount of the i (output) produceds = bankjs x = amount of the j (input) used by the banki u = output weightj v = input weightAccording to Yudistira [53], this efficiency ratio ( s e ) was then maximizedto select optimal weights as follows:182 Efficiency in Islamic Banking during a Financial Crisis111 , 1,..., , , 0mi irin i jj jrj

u yr N u vv x

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(2)According to Charnes et al. [15], this fractional linear system can bechangedMaximize1ms i isi

e uy

into an ordinary linear system in this way:Similarly, the system can be changed into the dual problem:minimize s

1 10 , 1,...,m mi ir j jri j

u y v x r N , and 0 1 s (3)s = overall technical efficiency score of bank with a value of 1 indicates thepoint on the frontier.1, 1,...,Nr ir isr

y y i m

10 , 1,..., ; 0Ns js r ir rr

x x j n

(4) Statistical tests for significance of the tests’ parameters are not needed because the DEA has the best production function based on the data that is observed. More than one DEA model exists. The study used the VRS model and utilizes an output based model whereas DMU’s are only

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considered optimal in the production of the best possible output from a certain input. The DEA make statistical tests for the parameter’s significance unnecessary. More than one DEA model exists.

Modeling after Yudistira, the researcher used the VRS model which is an output-oriented model and DMU’s would then be optimal when producing the most output from a certain amount of input. The study of the relative efficiency of the Islamic banks was done for the years 2006 to 2009. A different measure was done for each year. He utilized the DEA Excel Solver and also used the U.S. money system in the variables.

Islamic banks tend to issue reports in the currency of their country of operations.The researcher thus followed Pastor, Pérez, and Quesada [40] by converting theIslamic banks’ local currencies into U.S. dollars by using the exchange rate on thefirst date of the study implementation.After measuring efficiency with the DEA, tool for each bank from the yearof 2006 to 2009. A t test at the .05 level of significance facilitated theidentification of statistically significant differences in efficiency for the Islamicbanks. The choice of the t testing method was based on the goal of the research.The analyzed data were interpreted to answer the research question (i.e., AreIslamic banks stable and efficient during a financial crisis?) and to determinewhether to reject or fail to reject the null hypotheses about the efficiency ofIslamic banking systems. The null and alternate statements of hypothesis are asfollows:H1O: There is no difference in the efficiency between Islamic banks operate inMiddle Eastern and non-Middle Eastern Counties during an economic crisis.H1a: There is difference in the efficiency between Islamic banks operate in MiddleEastern and non-Middle Eastern Counties during an economic crisis.H2O: There is no difference in the efficiency between small and large Islamicbanks during an economic crisis.H2a: There is a difference in the efficiency between small and large Islamic banksduring an economic crisis.5.3 Definition of Variables

The intermediation method was used to measure the efficiency in Islamic banking, incorporating the DEA because this type of banking is considered to be equity based. In this model, the input was fixed assets,

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labor costs, and deposits. The output was liquid assets, loans, and other income. .5.4 Data

The data for this study was complied from year-end balance sheets and statements of income for the specific years of 2006 through 2009. This information was provided by the Islamic Banks and Financial Institutions Information’s database. As a result of the Yudistira study, the researcher took the position that the banks involved in this study operated optimally. The Islamic banks were in particular geographic areas, which were Middle Eastern countries and Non Middle Eastern countries. In addition the research looks at the size/efficiency correlation. Islamic banks were grouped by summary assets and thus banks with over $600 million in assets were called large and those with fewer assets were called small or medium sized. 6 Presentation of the Findings

The reason for this research was to look at the impact of the 2006 through 2009 financial crisis’ impact on efficiency procedures of several different banking institutions. These included non-Middle Eastern Islamic banks, Middle Eastern Islamic banks, large Islamic banks, and small to medium Islamic banks. The results suggest that the non-Middle Eastern Islamic maintained a certain amount of efficiency much better than the Middle Eastern Islamic Banks. The small to medium sized Islamic banks maintained efficiency on a higher level than large Islamic banks. The officers of both the large and small to medium banks noticed a growth in efficiency, however, during the years of the economic crisis.

6.1 Sample SummaryThe study sample used 47 Islamic banks—21 of these were in non-

Middle Eastern countries and 26 were in Middle Eastern countries. The samesample was used to compare large banks to small and medium sized banks-- 24 large Islamic Banks and 23 small to medium size Islamic banks.

In order to provide baseline information about the samples, Table 1, 2, and3 presents a summary of Total Assets for the periods.Tables 4, 5, 6 and 7 show a summary of the DEA mean, median and standard deviation for each sample from 2006 to 2009. 186 Efficiency in Islamic Banking during a Financial CrisisTable 1: Total AssetsTable 2: Total AssetsTable 3: Total AssetsIslamic Banks 2006 2007 2008 2009Sample Size 47 47 47 47Mean $ 4,966,895,488 $6,462,764,357 $7,205,820,298 $7,809,139,556Median $873,451,000 $871,594,000 $1,246,454,003 $929,893,797

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Standard deviations $13,457,222,061 $15,834,384,402 $16,420,080,388 $18,146,143,172Middle Eastern IslamicBanks 2006 2007 2008 2009Sample Size 26 26 26 26Mean $1,411,500,050 $2,780,944,405 $3,518,729,979 $3,712,822,443Median $27,687,769 $37,788,083 $71,808,889 $198,674,860Standard deviations $2,548,045,653 $5,373,789,027 $6,046,519,594 $6,245,599,215Non Middle EasternIslamic Banks 2006 2007 2008 2009Sample Size 21 21 21 21Mean $ 9,368,813,649 $11,021,208,108 $11,770,789,264 $12,880,770,266Median $ 1,326,099,018 $ 2,048,241,500 $ 2,031,496,124 $ 2,184,174,884Standard deviations $19,277,660,975 $22,386,063,733 $23,127,243,212 $25,685,971,321Ali Said 187Table 4: Data Envelopment AnalysisMiddle Eastern Islamic Banks 2006 2007 2008 2009Sample Size 26.00 26.00 26.00 26.00Mean 0.57 0.72 0.79 0.79Median 0.50 0.75 0.85 0.96Standard deviations 0.26 0.24 0.25 0.27Table 5: Data Envelopment AnalysisNon Middle Eastern IslamicBanks 2006 2007 2008 2009Sample Size 21.00 21.00 21.00 21.00Mean 0.78 0.79 0.81 0.79Median 0.94 1.00 1.00 1.00Standard deviations 0.30 0.29 0.31 0.32Table 6: Data Envelopment AnalysisLarge Islamic Banks 2006 2007 2008 2009Sample Size 24.00 24.00 24.00 24.00Mean 0.71 0.79 0.79 0.76Median 0.90 0.97 1.00 1.00Standard deviations 0.33 0.28 0.30 0.32188 Efficiency in Islamic Banking during a Financial CrisisTable 7: Data Envelopment AnalysisSmall to MediumIslamic banks 2006 2007 2008 2009Sample Size 23.00 23.00 23.00 23.00Mean 0.62 0.72 0.81 0.81Median 0.53 0.71 0.98 1.00Standarddeviations 0.25 0.23 0.24 0.266.2 Hypotheses 1

The question posed by the research was whether Islamic bnaks are stable and efficient during a financial c\crisis, namely the one beginning in 2006. The first hypothesis looked at a comparison regarding efficiency

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between Islamic banks operating in Middle Eastern and non Middle Eastern countries. Beginning with the first null hypothesis it assumed that there would be no difference in the efficiency in the efficiency. The researcher studied the differences in the figures for each over the course of four years. Table 8 shows the results of the t test regarding the efficiency. No significant difference was found in 2006. The P value was .194, .396, and .476 for the following three years, which supports the hypothesis. The efficiency of the banks has increased during an economic crisis. Non Middle Eastern Islamic banks demonstrated more efficiency than Middle Eastern Islamic banks in 2008. Table 8: t-Test Results: Hypothesis 12006 2007 2008 2009Middle Eastern Islamic Banks Mean 0.57 0.72 0.79 0.79Non Middle Eastern IslamicBanks Mean 0.78 0.79 0.81 0.79DifferencesT Value 2.501 0.871 0.264 0.061p Value 0.008 0.194 0.396 0.476Note: *p 0.056.3 Hypotheses 2

The question posed by the research was whether Islamic banks are stable and efficient during a financial crisis, namely the one beginning in 2006. The second hypothesis looked at the comparison between small to medium Islamic banks and large Islamic banks. The null hypothesis (2nd) was that no difference would be found between the banks due to size. Regarding this hypothesis, Table 9 shows the results of t tests for the difference in efficiency. There was a statistical significance for the years 2006 through 2009. The P values were 0.150, .165, .401 and .281, which shows verification of the second null hypothesis. Islamic banks considered in the “large” category showed an increase in efficiency for each of the year up to 2009, and for that year, a decline in efficiency. But, as the table shows, the other sized banks started out with a lower efficiency. Table 9: t-Test Results: Hypothesis 22006 2007 2008 2009Large Islamic Banks Mean 0.71 0.79 0.79 0.76Small to Medium Islamicbanks Mean 0.62 0.72 0.81 0.81DifferenceT Value 1.046 0.984 0.253 0.584

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p Value 0.150 0.165 0.401 0.281Note: *p 0.056.4 Recommendations for Further StudyThis study is one of few that looked at the efficiency of Islamic banks from different regions and different size institutions during a financial crisis. The entire purpose of the study was to reveal the deference in Islamic banks’ efficiency. The study results were also meant to show that the size of the bank and the area and location could change the efficiency of the bank during a financial difficulty.

7 Summary and Study ConclusionsThis study was for the purpose of getting a more in depth knowledge of

the efficiency of Islamic banks during a financial crisis. It is a comparison of the Islamic banking system with the efficiency of banks during the economic crisis between 2006 and 2009. The DEA was used as a measure. The research question answered was: Are Islamic banks stable and efficient during a financial crisis?

The null hypotheses were:H1: No differences in the efficiency of Islamic banks operation in Middle Eastern and non-Middle Eastern countries during an economic crisis. H2: There are differences in the efficiency of Islamic banks operation in Middle Eastern and non-Middle Eastern countries during an economic crisis. H1a: There are no differences in the efficiency of Islamic banks operation between small and large Islamic banks during an economic crisis.H2a: There are differences in the efficiency of small and large Islamic banks during an economic crisis. The whole reason for this study was to demonstrate that Islamic banks have differences in efficiency depending on the size and area of the bank during a financial crisis. Also, the reason for this study was to show that the size of the bank affects the efficiency during a financial crisis. During the years 2006 through 2008, larger Islamic banks increased in their efficiency but it went down in 2009. Smaller banks started out with a lower efficiency. Islamic banks located in both Middle Eastern and non-Middle Eastern countries had an increase in efficiency during an economic crisis. References[1] Al-Jarrah, I. and P. Molyneux, Efficiency in Arabian Banking, paperpresented at the International Conference on Financial Development in ArabCountries, (2003), Abu Dhabi, UAE.192 Efficiency in Islamic Banking during a Financial Crisis[2] M. Akhtar, X-Efficiency analysis of Pakistani commercial banks,International Management Review, 6(1), 2010, 12-23.

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