Keywords: Cost Efficiency, Technical Efficiency Islamic Windows, Stochastic Frontier Analysis


The study examines the cost and technical efficiency of selected Islamic banking windows of conventional banks in Ethiopia during the period of 2016-2020. The parametric method, stochastic frontier approach (SFA) was employed to measure both cost and technical efficiency of the banks. The efficiency scores of the sampled banks can be measured based on their performance in utilizing inputs to successfully generate output during the study period. It gauges the service quality of the banks taking loans and deposits as well as operating income and expenses into consideration. The study uses time series data from four conventional banks which provide Islamic banking widow in Ethiopia. The statistical findings show that the conventional banks have fairly better technical efficiency individually and collectively; however, the cost efficiency scores indicate that the banks are not efficient enough in terms of minimizing costs for a given scale and mix of outputs. Similarly, the results of the stochastic technical frontier estimates uncovers that there is positive significant relationship between the input variables namely total deposits and total operating expenses and output variables namely total financing and total operating income. The outputs remain an essential contributor to the cost efficiency in Islamic windows conventional banks in Ethiopia. 

JEL Classification Codes: G01, G21, G24.

Author Biographies

Abdu Seid Ali, Maxbridge Education and Development, Ethiopia

Head, Islamic Finance Department, Maxbridge Education and Development, Addis Ababa, Ethiopia

Suadiq Mehammed Hailu, Çukurova University, Turkey

PhD Candidate, Department of Finance, Çukurova University, Adana, Turkey


Abdul-Majid, M., Saal, D. S., & Battisti, G. (2010). Efficiency in Islamic and conventional banking: an international comparison. Journal of Productivity Analysis, 34(1), 25-43. https://doi.org/10.1007/s11123-009-0165-3

Adjei-Frimpong, K. (2013). Bank efficiency and bank competition: empirical evidence from Ghana's banking industry (Doctoral dissertation). Available from academia.edu

Aguenaou, S., Lahrech, A., & Bounakaya, S. (2017). Analyzing banks’ efficiency as a measurement of performance in the Moroccan context: Application of CAMEL Framework. International Review of Research in Emerging Markets and the Global Economy (IRREM), 3(1), 1105-1121.

Ahmad, W., & Luo, R.H. (2010). Comparison of banking efficiency in Europe: Islamic versus conventional banks", Kim, S.J. and Mckenzie, M.D. (Ed.) International Banking in the New Era: Post-Crisis Challenges and Opportunities (International Finance Review, Vol. 11), Emerald Group Publishing Limited, Bingley, pp. 361-389.

Ahmed, M. I. (2019). The progress to allow fully fledged interest free banking business in Ethiopia. European Journal of Islamic Finance, (14). https://doi.org/10.13135/2421-2172/4036

Aigner, D., Lovell, C. K., & Schmidt, P. (1977). Formulation and estimation of stochastic frontier production function models. Journal of econometrics, 6(1), 21-37. https://doi.org/10.1016/0304-4076(77)90052-5

Ali, A. S., Bushera, I., & Yesuf, A. J. (2020). The potential of Islamic financial institutions in promoting small and medium enterprises (SMEs) in Ethiopia. Journal of Economics and Political Economy, 7(3), 188-203. http://dx.doi.org/10.1453/jepe.v7i3.2091

Aman, A. W. (2020). Interest-free window banking and finance in Ethiopia: Inception to expansion. Journal of Economics Library, 6(4), 324-337. http://dx.doi.org/10.1453/jel.v6i4.2006

Berger, A. N. (2007). International comparisons of banking efficiency. Financial Markets, Institutions & Instruments, 16(3), 119-144. http://dx.doi.org/10.1111/j.1468-0416.2007. 00121

Bader, M. K. I., Mohamad, S., Ariff, M., & Shah, T. H. (2008). Cost, revenue, and profit efficiency of Islamic versus conventional banks: International evidence using data envelopment analysis. Islamic Economic Studies, 15(2). http://dx.doi.org/10.1177/0972150913515579

Bahrini, R. (2017). Efficiency analysis of Islamic banks in the Middle East and North Africa region: A bootstrap DEA approach. International Journal of Financial Studies, 5(1), 7. https://doi.org/10.3390/ijfs5010007

Battese, G. E., & Coelli, T. J. (1988). Prediction of firm-level technical efficiencies with a generalized frontier production function and panel data. Journal of econometrics, 38(3), 387-399. https://doi.org/10.1016/0304-4076(88)90053-X

Battese, G. E., & Coelli, T. J. (1992). Frontier production functions, technical efficiency and panel data: with application to paddy farmers in India. Journal of Productivity Analysis, 3(1), 153-169. https://doi.org/10.1007/BF00158774

Battese, G. E., & Coelli, T. J. (1995). A model for technical inefficiency effects in a stochastic frontier production function for panel data. Empirical Economics, 20(2), 325-332. https://doi.org/10.1007/BF01205442

Battese, G. E., Coelli, T. J., & Colby, T. C. (1989). Estimation of frontier production functions and the efficiencies of Indian farms using panel data from ICRISAT's village level studies (No. 400-2016-24556).

Battese, G. E., Heshmati, A., & Hjalmarsson, L. (2000). Efficiency of labor use in the Swedish banking industry: A stochastic frontier approach. Empirical Economics, 25(4), 623-640.

Benston, G. J. (1965). Branch banking and economies of scale. The Journal of Finance, 20(2), 312 331. https://doi.org/10.1111/j.1540-6261.1965.tb00212.x

Berger, A. N. (2007). International comparisons of banking efficiency. Financial Markets, Institutions & Instruments, 16(3), 119-144.

Berger, A. N., & Mester, L. J. (1997). Inside the black box: What explains differences in the efficiencies of financial institutions? Journal of Banking & Finance, 21(7), 895-947. https://doi.org/10.1016/S0378-4266(97)00010-1

Bhatia, V., Basu, S., Mitra, S. K., & Dash, P. (2018). A review of bank efficiency and productivity. Opsearch, 55(3-4), 557-600. https://doi.org/10.1007/s12597-018-0332-2

Casu, B., & Girardone, C. (2010). Integration and efficiency convergence in EU banking markets. Omega, 38(5), 260-267. https://doi.org/10.1016/j.omega.2009.08.004

Cham, T. (2018). Determinants of Islamic banking growth: an empirical analysis. International Journal of Islamic and Middle Eastern Finance and Management, 11(1), 18-39. https://doi.org/10.1108/IMEFM-01-2017-0023

Chowdhury, M. A. M., & Haron, R. (2021). The efficiency of Islamic Banks in the Southeast Asia (SEA) region. Future Business Journal, 7(1), 1-16. https://doi.org/10.1186/s43093-021-00062-z

Drake, L., & Hall, M. J. (2003). Efficiency in Japanese banking: An empirical analysis. Journal of Banking & Finance, 27(5), 891-917. https://doi.org/10.1016/S0378-4266 (02)00240-6

Eshete, Z. S., Tesome, K. W., & Abebe, T. K. (2013). Competition in Ethiopian banking industry. African Journal of Economics, 1(5), 176-190.

Fanta, A. B. (2012). Banking reform and SME financing in Ethiopia: Evidence from the manufacturing sector. African Journal of Business Management, 6(19), 6057-6069. https://doi.org/10.5897/AJBM11.3050

Fernandes, F. D. S., Stasinakis, C., & Bardarova, V. (2018). Two-stage DEA-Truncated Regression: Application in banking efficiency and financial development. Expert Systems with Applications, 96, 284-301. https://doi.org/10.1016/j.eswa.2017.12.010

Hailu, S. M., & Bushera, I. (2020). Interest Free Banking in Ethiopia: Prospects and Challenges. Uluslararası İslam Ekonomisi ve Finansı Araştırmaları Dergisi, 6(2), 119-137. https://doi.org/10.25272/ijisef.678972

Hassan, K. M. (2006). The X-efficiency in Islamic banks. Islamic Economic Studies, 13(2), 49-78.

Hassan, M. K. (2003). Cost, profit and X-efficiency of Islamic banks in Pakistan, Iran and Sudan. Islamic Financial Architecture, 497.

Hauner, D., & Peiris, S. J. (2008). Banking efficiency and competition in low income countries: the case of Uganda. Applied Economics, 40(21), 2703-2720. https://doi.org/10.1080/00036840600972456

Hussein, K. (2004). Banking efficiency in Bahrain: Islamic vs Conventional banks (No. 200). The Islamic Research and Teaching Institute (IRTI).

Hussein, K. A. (2001). Operational efficiency in Islamic banking: The Sudanese experience. Islamic Research and Training Institute, Islamic Development Bank.

Imam, P., & Kpodar, K. (2016). Islamic banking: Good for growth? Economic Modelling, 59, 387-401. https://doi.org/10.1016/j.econmod.2016.08.004

Islamic Financial Services Board. (2020). Islamic financial services industry stability report. Kuala Lumpur. Retrieved from https://www.ifsb.org/sec03.php

Ismail, F., Majid, M. S. A., & Rahim, R. A. (2013). Efficiency of Islamic and conventional banks in Malaysia, Journal of Financial Reporting and Accounting, 11(1), 92-107. https://doi.org/10.1108/JFRA-03-2013-0011

Johnes, J., Izzeldin, M., & Pappas, V. (2014). A comparison of performance of Islamic and conventional banks 2004–2009. Journal of Economic Behavior & Organization, 103, 93-107. https://doi.org/10.1016/j.jebo.2013.07.016

Kablan, S., & Yousfi, O. (2011). Efficiency of Islamic and conventional banks in countries with Islamic banking. Retrieved from https://mpra.ub.uni-muenchen.de/32951/

Kamaruddin, B. H., Safab, M. S., & Mohd, R. (2008). Assessing production efficiency of Islamic banks and conventional bank Islamic windows in Malaysia, International Journal of Business and Management Science, 1(1), 31-48.

Kamarudin, F., Sufian, F., Nassir, A. M., Anwar, N. A. M., Ramli, N. A., Tan, K. M., & Hussain, H. I. (2018). Price efficiency on Islamic banks vs. conventional banks in Bahrain, UAE, Kuwait, Oman, Qatar and Saudi Arabia: impact of country governance, International Journal of Monetary Economics and Finance, 11(4), 363-383. https://doi.org/10.1504/IJMEF.2018.095743

Kaparakis, E. I., Miller, S. M., & Noulas, A. G. (1994). Short-run cost inefficiency of commercial banks: A flexible stochastic frontier approach. Journal of Money, Credit and Banking, 26(4), 875-893. https://doi.org/10.2307/2077953

Kiyota, K., Pietsch, B., & Stern, R. (2007). The case for financial sector liberalization in Ethiopia, IPC Working Paper Series No. 29

Kraft, E., & Tırtıroğlu, D. (1998). Bank efficiency in Croatia: A stochastic-frontier analysis. Journal of Comparative Economics, 26(2), 282-300. https://doi.org/10.1006/jcec.1998.1517

Kumbhakar, S. C., & Lovell, C. K. (2003). Stochastic Frontier Analysis. Cambridge university press.

Lelissa, T. (2020). The Impact of COVID-19 on the Ethiopian Private Banking System. Available at SSRN 3624944.

McKinley, V., & Banaian, K. (2005). Central bank operational efficiency: meaning and measurement. Central Banking Publications, Available at SSRN: https://ssrn.com/abstract=2508461

Meeusen, W., & van Den Broeck, J. (1977). Efficiency estimation from Cobb-Douglas production functions with composed error. International Economic Review, 18, 435-444. https://doi: 10.12691/jbms-4-4-4.

Mohamad, S., Hassan, T., & Bader, M. K. I. (2008). Efficiency of conventional versus Islamic Banks: international evidence using the Stochastic Frontier Approach (SFA). Journal of Islamic Economics, Banking and Finance, 4(2), 107-130.

Mohd Noor, N. H. H., Bakri, M. H., Wan Yusof, W. Y. R., Mohd Noor, N. R. A., & Zainal, N. (2020). The impact of the bank regulation and supervision on the efficiency of Islamic Banks. The Journal of Asian Finance, Economics, and Business, 7(11), 747-757.

Mokhtar, H. S. A., Abdullah, N., & Al-Habshi, S. M. (2006). Efficiency of Islamic banking in Malaysia: A stochastic frontier approach. Journal of Economic Cooperation, 27(2), 37-70.

Mokhtar, H.S.A., Abdullah, N., & Alhabshi, S.M. (2008). Efficiency and competition of Islamic banking in Malaysia, Humanomics, 24(1), 28-48. https://doi.org/10.1108/08288660810851450

Parsa, M. (2022). Efficiency and stability of Islamic vs. conventional banking models: A Meta frontier analysis. Journal of Sustainable Finance & Investment, 12(3), 849-869. https://doi.org/10.1080/20430795.2020.1803665

Pradiknas, T. Y., & Faturohman, T. (2015). Efficiency of Islamic Banking Compared To Conventional Banking: Evidence From Indonesian Banking Sector. Journal of Business and Management, 4(5), 540-551.

Pramuka, B. A. (2011). Assessing profit efficiency of Islamic banks in Indonesia: An intermediation approach. Journal of Economics, Business, & Accountancy Ventura, 14(01), 94-106.

Qureshi, M. A., & Shaikh, M. (2012). Efficiency of Islamic and conventional banks in Pakistan: a non-parametric approach. International Journal of Business and Management, 7(7), 40. http://dx.doi.org/10.5539/ijbm.v7n7p40

Rosman, R., AbdWahab, N., & Zainol, Z. (2014). Efficiency of Islamic banks during the financial crisis: An analysis of Middle Eastern and Asian countries. Pacific-Basin Finance Journal, 28, 76-90. https://doi.org/10.1016/j.pacfin.2013.11.001

Saâdaoui, F., & Khalfi, M. (2022). Revisiting Islamic banking efficiency using multivariate adaptive regression splines. Annals of Operations Research, 1-29. https://doi.org/10.1007/s10479-022-04545-2

Sadalia, I., Kautsar, M. H., Irawati, N., & Muda, I. (2018). Analysis of the efficiency performance of Sharia and conventional banks using stochastic frontier analysis. Banks & Bank Systems, 13(2), 27-38. https://doi:10.21511/bbs.13 (2).2018.03

Safiullah, M., & Shamsuddin, A. (2020). Technical efficiency of Islamic and conventional banks with undesirable output: Evidence from a stochastic meta-frontier directional distance function, Global Finance Journal, 51, 100547. https://doi.org/10.1016/j.gfj.2020.100547

Said, A. (2012). Efficiency in Islamic banking during a financial crisis-an empirical analysis of forty-seven banks. Journal of Applied Finance & Banking, 2(3), 163-197. Available at SSRN: https://ssrn.com/abstract=2084626

Said, A. (2013). Evaluating the overall technical efficiency of Islamic banks operating in the MENA region during the financial crisis. International Journal of Economics and Financial Issues, 3(2), 426-434.

Salami, O. L., & Adeyemi, A. A. (2017). Malaysian Islamic banks’ efficiency: an intra-bank comparative analysis of Islamic windows and full-fledged subsidiaries. International Journal of Business and Society, 16(1). https://doi.org/10.33736/ijbs.551.2015

Scholtens, B., & Van Wensveen, D. (2003). The Theory of Financial Intermediation: An Essay on What It Does (Not) Explain (No. 2003/1) Vienna: SUERF Studies.

Sealey Jr, C. W., & Lindley, J. T. (1977). Inputs, outputs, and a theory of production and cost at depository financial institutions. The Journal of Finance, 32(4), 1251-1266. https://doi.org/10.1111/j.1540-6261.1977.tb03324.x

Sharma, S. K., & Dalip, R. (2014). Efficiency and productivity analysis of Indian banking industry using Hicks-Moorsteen approach. International Journal of Productivity and Performance Management, 63(1), 57-84. https://doi.org/10.1108/IJPPM-09-2012-0096

Sherman, H. D., & Gold, F. (1985). Bank branch operating efficiency: Evaluation with data envelopment analysis. Journal of Banking & Finance, 9(2), 297-315. doi.org/10.1016/0378-4266 (85)90025-1

Sillah, B. M., & Harrathi, N. (2015). Bank efficiency analysis: Islamic banks versus conventional banks in the Gulf Cooperation Council Countries 2006-2012. International Journal of Financial Research, 6(4), 143-150. https://doi.org/10.5430/ijfr.v6n4p143

Sufian, F. (2007). The efficiency of Islamic banking industry in Malaysia: Foreign vs domestic banks, Humanomics, 23(3), 174-192.

Sufian, F., Mohamad, A. M., & Muhamed-Zulkhibri, A. M. (2008).Tahir, I. M., & Haron, S. (2010). Cost and profit efficiency of Islamic banks: international evidence using the stochastic frontier approach. Banks & Bank Systems, 5(4), 78-83.

Tahir, I. M., Abu, B. N., & Haron, S. (2008). Technical efficiency of the Malaysian commercial banks: A stochastic frontier approach. Banks & Bank Systems, 3(4), 65-72.

Weill, L. (2009). Convergence in banking efficiency across European countries. Journal of International Financial Markets, Institutions and Money, 19(5), 818-833. https://doi.org/10.1016/j.intfin.2009.05.002

Xiaogang, C., Skully, M., & Brown, K. (2005). Banking efficiency in China: Application of DEA to pre-and post-deregulation eras: 1993–2000. China Economic Review, 16(3), 229-245. https://doi: 10.1016/j.chieco.2005.02.001

Yudistira, D. (2004). Efficiency in Islamic banking: an empirical analysis of eighteen banks. Islamic Economic Studies, 12(1), 2-19.

Yusuf, A. A., Santi, N., & Rismaya, E. (2021). The efficiency of Islamic banks: Empirical evidence from Indonesia. The Journal of Asian Finance, Economics and Business, 8(4), 239-247. https://doi.org/10.13106/jafeb.2021.vol8.no4.0239

Yahya, M. H., Muhammad, J., & Hadi, A. R. A. (2012). A comparative study on the level of efficiency between Islamic and conventional banking systems in Malaysia. International Journal of Islamic and Middle Eastern Finance and Management, 5(1), 48-62. https://doi.org/10.1108/17538391211216820

Zaim, O. (1995). The effect of financial liberalization on the efficiency of Turkish commercial banks. Applied Financial Economics, 5(4), 257-264. https://doi.org/10.1080/758536876.

Zuhroh, I., Ismail, M., & Maskie, G. (2015). Cost efficiency of Islamic banks in Indonesia–a stochastic frontier analysis. Procedia-Social and Behavioral Sciences, 211, 1122-1131. https://doi.org/10.1016/j.sbspro.2015.11.150
How to Cite
Ali, A. S., & Hailu, S. M. (2022). EFFICIENCY OF ISLAMIC BANKS: EVIDENCE FROM ISLAMIC WINDOWS OF CONVENTIONAL BANKS IN ETHIOPIA. International Journal of Islamic Banking and Finance Research, 9(1), 21-31. https://doi.org/10.46281/ijibfr.v9i1.1768
Original Articles/Review Articles/Case Reports/Short Communications