How did Islamic Banks Perform During and after the Global Financial Crisis? Evidence from the GCC Countries

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1. Journal of Emerging Issues in Economics , Finance and Banking (JEIEFB) An Online International Research Journal (ISSN: 2306-367X) 2018 Vol: 7 Issue: 1 How did Islamic Banks Perform During and after the Global Financial Crisis? Evidence from the GCC Countries Raéf Bahrini, University of Jeddah, College of Business (Accounting Department), Saudi Arabia. E-mail: rbahrini@uj.edu.sa Alaa A. Qaffas, University of Jeddah, College of Business (Head of Accounting Department), Saudi Arabia. E-mail: aaqaffas@uj.edu.sa ___________________________________________________________________________ Abstract The purpose of this paper is to measure and analyze the technical efficiency of 17 full-fledged Islamic banks operating in 5 Gulf Cooperation Council (GCC) countries, during and after the global financial crisis (2006-2012). We apply the bootstrap Data Envelopment Analysis (DEA) approach developed by Simar and Wilson (1998) in order to assess bias-corrected estimates of technical efficiency. Our results show the presence of a significant estimation bias that affects the efficiency scores obtained from the standard DEA method. After using the bootstrap DEA approach, we conclude that bias-corrected efficiency scores of GCC Islamic banks have not been directly affected by the global financial crisis either during the crisis period (2007-2008) as well as in the post-crisis period (2009-2011). However, a slight decline in GCC Islamic banks’ overall technical efficiency was recorded in the last year of the post-crisis period (2012). Furthermore, results indicate pure technical inefficiency was the main source of overall that over technical inefficiency over the study period. These findings allow us to recommend that GCC Islamic banks should improve their managerial performance especially in using and allocating resources. In addition, policy-makers in the GCC region should support the expansion of Islamic banking activities by developing a more favorable environment for Islamic banks. ___________________________________________________________________________ Key Words: Islamic banks, technical efficiency, GCC, global financial crisis, DEA, bootstrap JEL Classification: C61, G01, G21 2452 www.globalbizresearch.org
2. Journal of Emerging Issues in Economics , Finance and Banking (JEIEFB) An Online International Research Journal (ISSN: 2306-367X) 2018 Vol: 7 Issue: 1 1. Introduction The global financial crisis of 2007-2008 known also as the subprime crisis was one of the most dramatic financial crises that had a substantial negative impact not only on the United Stated economy but also on the major economies in the world. This crisis has caused many difficulties to conventional banks especially in the US but also all over the world. However, this was not the case of Islamic banks which are believed to be more resilient during this financial crisis than their conventional counterparts because they adopt a different business model. Islamic banks are different from conventional banks because they are governed by different rules. They have to comply with Shariah which is the Islamic law. Hence, following Shariah’s rules, Islamic banks must avoid interest (riba) and therefore they are not allowed to receive interest on loans or to pay interest on deposits (Chong and Liu, 2009). In addition, Islamic banks are prohibited by Shariah form undertaking transactions that involve excessive risk or uncertainty (gharar), gambling (maysir) and religiously forbidden (haram) products (Khan, 2010). Moreover, Islamic banks differ from conventional banks because they adopt the Profit-and-Loss-Sharing (PLS) paradigm. Under this paradigm, they offer Islamic financing modes that allow the parties involved in the transaction to share profits and losses according to a mutually agreed rate (Dar and Presley, 2000). In fact, many reports and studies showed that because of their different business model Islamic banks posted higher credit and asset growth rates, had higher profitability levels, asset quality and were better capitalized that conventional banks during the global financial crisis (Hassan and Lewis, 2007; Cihak and Hesse, 2010; Farooq and Zaheer, 2015, etc.). Indeed, the latest reports provided by the International Monetary Fund (IMF) and the World Bank show that Islamic banking was one of the fastest sectors in the world with an average increase in total assets of 16% per year between 2003 and 2013. According to Standard and Poor’s Islamic banking assets exceeded $2,000 billion in 2015 and is expected to further double in size in 2020. This strong growth reflects growing demand from Muslim populations, and strong economic growth in countries where the industry already exists. Moreover, many previous studies showed that Islamic banks are playing an important role in the financial sector by providing new and distinctive financing services which have a positive impact on the economic growth in many countries especially in the GCC region (Demirgüç-Kunt, et al. 2013; Tabash and Dhankar, 2014; Kammer et al. 2015). Despite these results, some studies showed that in some cases the global financial crisis had a negative impact on the performance of Islamic banks especially in the post crisis period (Hasan and Dridi, 2010; Alqahtani et al., 2016). 2453 www.globalbizresearch.org
3. Journal of Emerging Issues in Economics , Finance and Banking (JEIEFB) An Online International Research Journal (ISSN: 2306-367X) 2018 Vol: 7 Issue: 1 Other studies have not identified a clear impact of the subprime crisis on Islamic bank’s performance (Ftiti et al., 2013; Samad, 2013; Mobarek and Kalonov, 2014, etc.). Literature review reveals that most previous studies have assessed Islamic banks’ performance by using profitability and stability measures. In addition, unlike studies on conventional banks, the impact of the crisis on the efficiency of Islamic banks is an area still unexplored given that relatively few studies have compared efficiencies of Islamic banks before and after the crisis (Belanès et al., 2015). Moreover, the existing studies on the efficiency of Islamic banks in the GCC countries were scarce despite the fact that these countries enclose the two-thirds of Islamic banks' number as well as 70% of their total assets (Islamic Banking Sharia Compliant Law Report, 2013). In an attempt to enrich the existing literature, this paper aims to provide a better understanding of how did GCC Islamic banks perform during and after the global financial crisis period in terms of technical efficiency. Our study consists of measuring and analyzing the technical efficiency of selected full-fledged Islamic banks operating in GCC countries during and after the global financial crisis (2006-2012). We use the bootstrap DEA approach, elaborated by the pioneer works of Simar and Wilson (1998), in order to provide more biascorrected measures of Islamic banks’ technical efficiency and robust analysis of efficiency changes before, during and after the global financial crisis period. The reminder of this paper is organized as follows. Section 2 provides a brief literature review. Section 3 describes the methodology. Section 4 presents the data and the variables used. Section 5 reports and discusses the results. Conclusions are presented in Section 6. 2. Literature Review Previous literature on the efficiency of Islamic banks show that several studies have focused on assessing the efficiency levels of sampled banks, analyzing efficiency changes during different periods of time and investigating the sources of any discovered inefficiencies (see Yudistira, 2004; Hassan, 2006; Sufian, 2007; Tahir and Haron, 2010; Noor and Ahmad, 2012, Mobarek and Kalonov, 2014; among others.). These studies have used several efficiency concepts, such as technical, cost, profit and revenue efficiency, and employed parametric methods (such as the Stochastic Frontier Approach, SFA) and non-parametric methods (such as the DEA method) Furthermore, literature reveals that few studies have focused on the impact of the global financial crisis 2007-2008 on the efficiency of Islamic banks. This was particularly true in the case of GCC region despite the importance of this region for Islamic banking as a whole. Aiming to provide a better understanding of how Islamic banks performed during the global financial crisis a few cross-country studies have been conducted. 2454 www.globalbizresearch.org
4. Journal of Emerging Issues in Economics , Finance and Banking (JEIEFB) An Online International Research Journal (ISSN: 2306-367X) 2018 Vol: 7 Issue: 1 Noor and Ahmad (2012) have employed the DEA method in order to measure the overall technical efficiency of a sample of 78 Islamic banks operating in 25 countries during the period 1992–2009. Their findings show that Islamic bank’s efficiency scores have increased during and after the global financial crisis period. They explained their results by the fact that the Islamic banking model became more attractive to depositors and investors at the expense of conventional banking. A similar result was found by Srairi and Kouki (2012), who employed the DEA method on a data of 25 Islamic banks from the GCC countries during the period 2003-2009. Moreover, Rosman et al. (2014) showed that the technical efficiency scores of Middle Eastern and Asian Islamic banks have increased during the global financial crisis period (2007-2008). However, only Islamic banks from Middle Eastern countries have known a decrease in their efficiency levels during the post-crisis period (2009-2010). More recently, Belanès et al. (2015) investigated the impact of the subprime crisis on the efficiency of 30 GCC Islamic banks over the period 2005-2011. They found that Islamic banks in GCC countries have been almost efficient before and during the subprime crisis, but they witnessed a slight decrease in their technical efficiency in the post crisis period. Following these authors, the most important decrease in technical efficiency of GCC Islamic banks was recorded in 2009; that is two years after the subprime crisis occurrence. In contrast to the previous results, some other studies did not find any improvement of the technical efficiency of Islamic banks during and after the financial crisis of 2007-2008. Ftiti et al. (2013) found that the subprime crisis had not any significant impact on the overall technical efficiency of 30 GCC Islamic banks during the period 2005-2009. Samad (2013) confirmed this finding when he compared the efficiency levels of 28 Islamic banks across 16 different countries before and after the global financial crisis. Similar results were found by Mobarek and Kalonov (2014) who have applied both the DEA and the Stochastic Frontier approach (SFA) on Islamic and conventional banks from 18 OIC (Organization of Islamic Conference) countries during and after the crisis period. In total, this literature review shows that the effect of the global financial crisis on the efficiency of Islamic banks all over the world, and particularly in GCC countries, is still not clear and need more in-depth investigation. 3. Methodology Measuring and analyzing bank’s technical efficiency can be done by using frontier estimation methods such the parametric method SFA and the non-parametric method DEA (Berger and Humphrey, 1997; Berger and Mester, 1997). Both methods have advantages and disadvantages. 2455 www.globalbizresearch.org
5. Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB) An Online International Research Journal (ISSN: 2306-367X) 2018 Vol: 7 Issue: 1 SFA parametric method has the advantage to allow for random error in the measurement of efficiency, while the DEA non parametric in its standard form has an important weakness which consists in considering all deviations from the frontier as inefficiency. However, many previous studies preferred using the DEA non-parametric method instead of the SFA method because it is more flexible in constructing the efficiency frontier, while the former imposes a number of strong assumptions as to the functional form of the efficiency frontier that are difficult to justify. In addition, DEA method estimates the best-practice frontier which envelops the observations, allowing each bank to have its own objectives as it will only be compared with banks of similar input and output mix. Thus, it compares “like with like” which means that it doesn’t require specification of functional form or distribution like in the SFA method (Johnes et al., 2014). It is also important to add that unlike DEA, which is more suitable for small samples like in our case, the SFA method requires large numbers of degrees of freedom, which means that it requires large sample sizes. For these reasons, we prefer using DEA method to estimate technical efficiency of GCC Islamic banks in our study (Coelli et al., 2005). 3.1 Standard DEA models The DEA model initially proposed by Charnes et al. (1978) called the CCR model. This model assumes that all Decision Making Units (DMUs) are operating under a Constant Return to Scale (CRS). Consider n DMUs (DMUs are banks in our study), each DMUj (j runs from 1 to n) is producing m different inputs using s different outputs. With reference to Cooper et al. (2011), the technical efficiency score of a particular bank is determined by the dual linear problem as follows: