Performance Analysis of Islamic Banking in Pakistan Using DEA Technical Efficiency and Maqasid e Shariah Index

Abstract

The outlook of Pakistan’s Islamic banking industry remained positive over the decade based on business growth projections and as a fact played significant role in promotion of local as well as foreign direct investment. Industry crossed a landmark of 2 trillion deposits last year and still growing with an increasing rate. Shariah banks are using a unique business model which is designed under the principles of Islamic Sharia. They are providing sharia compliant products to customer therefore, gaining popularity in the country. Unlike traditional counterparts, Shariah banks had dual challenge they need to remain efficient and sharia compliant as well. This study examines the efficiency of Pakistan’s Islamic banking industry using DEA Technical Efficiency Scores and Sharia performance Ratio which is assessed through Maqasid e Sharia Index. Technical efficiency measured by using DEAP 2.1 software and Maqasid e Sharia Index measured through the weighted average of ten ratios. Results of Efficiency and MSI plotted on four quadrants based on score combinations calculations are relative not absolute. This study has 4 main findings on the basis of results plotted on four quadrants. Bank falls in Quadrant 1 is considered to be the best bank which achieved high level of technical efficiency and High level of Maqasid e Sharia Index score. Mezaan Bank falls in Quadrant 1 means that achieved high efficiency score and having high MSI scores. Islamic bank falls in Q2, achieved high technical efficiency and low sharia performance. Dubai Islamic bank secured place in Q2 which due to low score of MSI, management of bank need to align focus towards sharia performance besides technical efficiency. Bank falls in Q3 secured low score in technical efficiency and high score in sharia performance. Bank Islami and Albaraka Bank managed to secure position in Q3 which is again a grey block they need to work on technical efficiency side. Q4 is danger zone, in this quadrant those banks fall that have low technical efficiency and sharia performance. None of the bank in industry secured place in Q4 which is good sign. After plotting technical and shariah efficiency scores, performance of Islamic banks analyzed through regression, wherein return on asset is taken as dependent variable, results states that there is positive association between return on asset and technical efficiency and impact of TE on ROA is highly significant. Same way positive association found between ROA and Maqasid e Shariah Index and impact of MSI is highly significant on ROA. While other efficiency measures taken control variables such as Financing expense to total spread, Admin expense to profit before tax, other expense to total income have negative association with ROA means that higher the expense lower the ROA and impact is also highly significant. Other expense to other income has negative association with ROA but its impact on ROA is insignificant. This study would have practical implications and raise questions for all stakeholders whether SBP supervision is enough in terms of achievement of sharia goals? In context to Pakistan, this will be the first study where Performance of Shariah banks analyzed on the basis of Technical efficiency as well Sharia Efficiency.