The impact of credit and operational risk on islamic and conventional bank efficiency in Malaysia

Abstract

In banking sector, evaluation of performance and productivity are among fundamental concepts in management to achieve firm’s goals. High levels of efficiency through performance and continuous efforts of managers are needed in order to be successful in the competitive markets. Institutions need to know their relative success according to performance in comparison with similar institutions and their performance for the past years. In this study, the economic efficiency was analyzed and compared in terms of risk factors for Islamic and conventional banks in Malaysia for the period of 2008 to 2012. The study was conducted on the banks certified by Central Bank of Malaysia (Bank Negara) which includes both Islamic and conventional branches. Data was collected from annual financial reports such as balance sheets and income statements. Data envelopment analysis (DEA) was implemented to determine and analyze the economic efficiency. Based on the intermediation approach, three inputs and two outputs were selected. Basel 2 was used to define the credit and operational risks on efficiency. In addition, DEA network model was proposed to estimate the overall efficiency (with regard to credit and operational risk) of banks and to specify the difference between Islamic and conventional banks in terms of efficiency using the nonparametric test such as Mann-Whitney and Wilcoxon. The result indicates that the credit and operational risk have significant impact on efficiency for both Islamic and conventional banking system. The non-performing loan has negative impact on efficiency in both Islamic and conventional banks which leads to undesirable output of banking system. In contrast, return on equity and return on assets show positive impact on efficiency of banks in Malaysia. The results also reveal that the efficiency of Islamic banks in Malaysia is higher than conventional and the differences are statistically significant. In addition, the efficiency is higher than the overall efficiency (efficiency with regard to credit and operational risk) of banks in Malaysia. The finding also indicates that there is no difference between overall efficiency of Islamic and conventional banks in Malaysia.