Chapter 1

INTRODUCTION

In this chapter we discussed the efficiency of Islamic banks in Pakistan.

Efficiency generally describes the extent to which time effort or cost well

used for the intended task or purpose. It is often used with the specific

purpose of relaying the capability of a specific application of effort to

produce a specific outcome effectively with a minimum amount or

quantity of waste expense or unnecessary effort. Efficiency has widely

meaning in many different ways. For this purpose we use at least twenty

articles review from which we learned that how Islamic and conventional

banks working Pakistan Islamic banking system introduced as a response

of both Islamic and economic needs. Different steps for the elimination of

rib in the economy was taking during 1970’s.And major and practical

steps were taken in the mid of 1980s.The project to re-introduce the

Islamic banking was start back in 2001 when the government strong-

minded to encourage the Islamic banking in a gradual way and as a

parallel and well-matched system that is in line with best international

practices. Moreover it determines to construct a wide financial system in

the country that makes the people able all parts of the population to right
to use this financial system. Conventional financing system is based on

the principal charging interest. But Islamic financing system is based on

the principal of interest free and fair distribution of wealth. While a

commercial bank is a type of bank that provides the services such as

accepting deposits making business loans and offering basic investment

products. This study is an attempt to understand financial health of

Islamic and conventional finance in term of utilizing ratios. The study

measures the technical and cost efficiency of Islamic and conventional

banks by using the stochastic frontier approach. The results shows the

positive relationship between bank efficiency, size and profitability while

show the negative relationship between bank efficiency and loans

intensity and Capitalization. While Islamic banking is the system of

banking consistent with the principles of Islamic law (sharpie) and guided

by Islamic economics. Islamic economics is referred to the body of

knowledge which helps realize human well being through an allocation

and distribution of scarce recourses that is in conformity with Islamic

teachings. In Islam profit is defined as a reward of capital. Islamic

banking department was established in the central bank of the country

namely State bank of Pakistan. Globally two strategies were

recommended for Islamic banking of Pakistan. The first strategy is known

as revolutionary strategy which Iran followed for the introduction of

Islamic banking. The second one is evolutionary strategy which Pakistan

announced for the introduction of Islamic banking system in the

country.simi par approach is followed in Indonesia and Malaysia.

According to June 2011 in Pakistan the number of full fledged Islamic

banks is 497.and Islamic branches of conventional banks is 253.and sub

branches is 49,total branches is 799.Howevere Islamic banking is steadily

moving into an increasing number of conventional financial system.

Moreover the efficiency of Islamic banks was improving with the passage

of time. The pure Islamic banks are working more efficiently as compared

to Islamic banks branches operated by conventional banks. This study

suggests that Islamic banks should increase total assets and profit because

these variables have positive impacts on efficiency while liabilities have

negative impact on efficiency. The current global financial disaster has not

only get rid of doubts on the proper functioning of conventional western

banking, but has also enlarged the attention on Islamic banking.acadamies

and policy makers alike point to the return shriah-compliant financial

yield as the disparity of short term, on sight demandable deposits

contracts with long term tentative loan contracts is mitigated with equity

fundamentals. In accumulation shariah-complaints products are very eye-

catching for segments of the population that claim financial services that

are dependable with their religious values. On the other hand little

academic facts exists on the implementation of Islamic banking as of up

till now. This paper describes some of the most familiar Islamic banking

products and associations their stricture to the theoretical literature on

financial intermedition.In particular we discuss to which point Islamic

banking products influence the agency problems arising from information

asymmetries between lender and borrower or investor and manager

funds.Shria-complaints finance does not permit for the charging of

interest payments (riba) as only goods and services are permitted to carry

a price. On the other hand shria-compliant finance relies on the blueprint

of profit or loss and risk sharing on both the asset and liability side.

Practice conversely Islamic scholars have developed products that look

like the conventional banking products, replacing interest rate payment

and discounting with fees and contingent compensation structures. In

accumulation leasing like products are accepted along with Islamic banks,

as they are directly associated to real sector transactions.cosidering the

performance of Islamic and conventional banks during the latest crisis we

find, little differences apart from those Islamic banks increased their

liquidity investment in the run-up to and during the crisis comparative to

the conventional banks. This also explains why Islamic banks stocks

performed better during the crisis compared to the conventional banks

stocks. Foreign investment in Pakistani Islamic banking industry is giving

the industry a unique outlook throughout which success transfer is taking

place as experiences as organism shared leading to the development of the

local industry.

1.1 Objectives of the study

The objective of the study is to analysis the efficiency of Islamic banks in

Pakistan.

1.2 Significance of the study

Pakistan is an Islamic country. And in Islam interest is prohibited very

strictly. Because of it many social evils prevails in the society and it is a

great hindrance in the fair distribution of wealth. And Islamic banking

system is an interest free system because it follows the principle of

shriah.So as a Muslim we should introduce the Islamic banking system in

pakistan.Because as a Muslim it is our first and necessary obligation to

introduce and implementation of Islamic banking system in Pakistan.

1. To find out the efficiency of Islamic Banking System in Pakistan

 2. To analyze the efficiency for two years i.e. initial year 2008 and

final year 2012

3. To suggest policy suggestions on the topic.

1.3 Organization of the study

The first chapter consists on introduction and in the second

chapter we present a detailed literature review and the third

chapter presents theoretical frame work and forth chapter consist

on data and methodology and fifth chapter consists on the results

and discussion and at the end we give conclusion.

Chapter 2

SURVEY OF LITERATURE

2.1 Introduction

In this chapter we will do three things, first we will write introduction

then literature survey in which we discussed at least twenty about the

efficiency of Islamic and conventional banks in Pakistan of different

writers and at the end we discussed the conclusion.

2.2 Literature Survey

Chatti, Kablan and Yousifi 2013, examined to analyze the diversification

among financial activities of Islamic banks and how it affects bank

performance in Malaysia. We used the Herfindahl Hirschman index to

measure the degree of act / liability diversification and risk adjusted

performance or criteria of assets allocation and management

compensation. Data are collected from the annual financial statements of

eight Malaysian banks over the period of 2004-2008. Three ratios are used

to measure the risk adjusted return that are extensions of financial index>
return on risk, adjusted capital (RORAC) risk adjusted return on capital

(RoRAC) and risk adjusted return on risk adjusted capital (RARORAC).

We found that retail and commercial found that retail and commercial

activity are the most profitable activity, which lead it ran over investment

in those activities. Some banks show high average correlation between

commercial and retail activities and corporate and investment activities.

The analysis of the efficiency shows that none of these banks falls on the

frontier which means that they should change the structure of their

portfolio in order to become less concentrated. They should also allocate

more assets to treasury activity.

Hanif et al (2012) examined the performance of Islamic and

conventional banking in Pakistan to find out which of the banking stream

is performing better than, other. For this study sample of 22 conventional

banks and 5 Islamic banks were selected. Nine financial ratios were used

to gauge profitability, liquidity and credit risk. And a model known as

embank-o-meter is used to gauge solvency. Nine financial ratios (RoA)

return on assets, return on equity, cost income ratio, net loans to assets

ratio, liquid assets to customer deposits and short term fund net leaner to
deposits and borrowing common equity to total asset and etc used. In

order to achieve the objectives we selected period of 5 years 2005-2009.

The data which is used is secondary data collected from state bank of

Pakistan. Finding suggest in term of profitability and liquidity

conventional banking leads while in credit risk management and solvency

maintenance Islamic banking are the location and Shari compliance, while

in case of conventional banking it is wide range of products and services.

Mokhtar ET. al., (2006) examined the efficiency of the full fledged

Islamic banks, Islamic windows and conventional banks in Malaysia. This

study examined the efficiency of Islamic banking industry in Malaysia

from 1997 to 2003 by using stochastic frontier approach technique. For

the choice of input and output variables this study uses two input

variables and one output variables. The first input variable devoted by X 1

is total deposits. The second input variable is X 2 is total overhead

expenses which include personal and other operating expenses. In the

calculation of cost efficiency two input prices are added, prices of

physical capital denoted by W1 and prices of deposits denoted by W2.

Finally total cost denoted by TC. This study used 288 panel data from the

annual reports of 20 Islamic banks and 20 conventional banks from 1997

to 2003. Some of the information was also obtained from the bank.
Negara Malaysia reports, the findings show that the average efficiency of

the overall Islamic banking industry has increased during the period of

study while the efficiency trend for conventional banks has been stable

over time. However, the efficiency level of Islamic banking is still less

efficient than that of conventional banks. This study also reveals that fully

fledged Islamic banks are more efficient than Islamic windows.

Yuoistira (2004) focused on this question technical pure technical

and scale efficiency measures are calculated by utilizing non parametric

technique data involvement analysis. Data envelopment analysis is a

linear programming technique for examining how a particular decision

making unit operates relative to the other bank in the sample. Two input

variables (Fined assets and staff costs) and one output variable (other

income) show similarity across the sample period based on mean and

standard deviation from non consolidated income statement and balance

sheet of 18 Islamic banks during the period of 1997-2000 which are made

available by the London based international bank credit analysis LTD’s

bank scope database. Several conclusions emerge, first the overall

efficiency results suggest that inefficiency across 18 Islamic banks is

small at just over 10 years, which is quite low compared to many

conventional banks. Islamic banks in the sample suffered from the global
crisis in 1998-99 but performed very well after difficult periods. The

findings indicate that there are diseconomies of scale for small to medium

Islamic banks which suggest that mergers should be encouraged.

Ali ET. al., (2012) examined the impact of profitability determinants on

performance of Islamic banks in a manner corresponding to such studies

conducted with conventional banks in Pakistan. To determine the

Profitability of Islamic banking in Pakistan. Five eternal economic factors

are used (I) GDP (real growth rate), (ii) industrial production rate (iii)

interest rate (IV) inflation (v) unemployment. The profitability was

determined through return on asset and return on equity. The time period

of the data was taken from 2003 to 2009. Hypothesis was tested and

discussion is done on the basis of data. So the study finds no major

distinction in profitability and liquidity performances between Islamic and

conventional banks.

Waisiuzzman and Gunasegauan (2013) examined and analyze the

difference in the bank characteristics of Islamic and conventional banks in

Malaysia. The study used the financial statement and statement of

corporate governance of both conventional and Islamic banks in Malaysia.

The time period of the sample data was taken from 2005 to 2009. Ratios

are used in this study as a variable. Return on average asset measures how
well a company used it assets to generate additional profit and can be

calculated by dividing net income after tax with the average asset. Value

for a given period of time. To determine the difference were significant

the t-test was carried on variables. The findings are that return on average

assets, bank size and board size values of conventional banks was higher

compared to Islamic banks. The other variables, operational efficiency,

asset quality liquidity, capital adequacy and board independence were

higher for Islamic banks. Significant difference between two banks was

found for all variables except profitability and board independence.

Except liquidity all variables found to be highly significant in affecting

profitability.

Yazdan and Hussain (2012) examined the short run and long run

relationship between Islamic banking development and economic growth

in Iran and Indonesia. For this purpose this paper used the quarterly data

(200:1-2010:4) and used the method of bound testing approach of co-

integration and error correction models, developed within an

autoregressive distributed log (ARDL) approach. In these paper three

dependent variables used which are (I) gross domestic product (ii) gross

fined capital formation (iii) total Islamic bank financing (FIN). The data

was collected for this article from the World Bank statistics and
international financial statistics published by the international monetary

fund. The results show a significant relationship between Islamic financial

development and economic growth in the short run and ling run time

periods. This paper used empirical evidence to show the role of Islamic

banks financing towards economic performance of a country.

Iqbal (2001) examined that there is a serious lack of empirical students on

Islamic banking. And he seriously attempted in this paper to fill this gap.

The performance of Islamic banks has been calculated banks has been

calculated using both trends and ratio analysis. In this paper ratio’s has

been used like rate on return on equity ratio, rate on return on assets ratio,

profitability ratio, cost / income ratio, development ratio, liquidity ratio

and capital asset ratio. For this study the data is collected from 1990-98

periods. And data of a large number of variables collected from the annual

reports of these bank. It has been found that generally Islamic banks have

done honestly well during the period under study.

Samad and Hassn in (1999) emphasized and evaluations inter-temporal

and intern bank performance of Islamic banks (Bank Islam Malaysia

Berhad) in profitability, liquidity risk and solvency and community

involvement for the period 1984-97. Financial ratios are used in

measuring these performances. T-test and F-test are used in determining

their significant. Finding of the study are that bank Islam Berthed

Malaysia is relatively more liquid and least risky compared to a group of

8 conventional banks.
Islam and chowdhury 2011 examined and focused on the comparative

liquidity situation of Islamic and conventional banks in Bangladesh for

the period of 2003 to 2006.different ratios are used as a variable such as

credit on investment deposit ratio, return on asset, earning per share, price

earnings ratio(times) and investment margin. Multiple regression analysis

was used for Islamic and conventional banks of Bangladesh. The data

source of the article is Islamic and conventional banks of Bangladesh.

From the whole analysis we see that Islamic bank of Bangladesh limited

showed relatively better performance in liquidity management then the

AB bank limited for the period of 2003 to 2006 both on short term and

long term basis.

Amaliawiati and Lasmanah 2014 examined that commercial banks can be

said to be valuable intermediary function as an organization

intermediaries when followed by a high level of efficiency in their

business activities in Indonesia. This study used the method of hypothesis

testing to see the difference between the effective functioning of

conventional and Islamic banks we used the t-test statistic. different ratios

are used such as adequacy capital ratio, on performing loan, on-

performing finance, net interest margin, loan to deposit ratio etc.The data
required in this study is secondary data are monthly time series data from

jan2010 to sept2013,the data obtained from the bank of Indonesia. The

study showed the results that based on the calculation of the average

difference test there is a significant difference between the effectiveness

of intermediation function between Islamic and conventional banks. And

Islamic banking has intermediation average more than conventional

banks.

Dost and Ahmad 2011 examined the scale efficiency scores of Islamic

banks of Pakistan for the period of 2006 to 2009.To determine the scale

efficiency 5 Islamic banks have been taken which is working in Pakistan.

Data for this study has been taken from the each banks annual reports and

each banks own website for the period of 2006 to 2009.Data envelopment

analysis is a non paramedic efficiency measuring technique which is used

for the analysis of the Islamic banks. The variable used for the analysis is

deposits and total assets are inputs while investment and net spread earned

are the outputs which are used for the analysis. The results shows that the

Dawood Islamic bank was the more efficient bank in pakistan.the results

also suggested that the Islamic bank had the highest mean scale efficiency
value during the period if 2007.this study is the early effort to determine

the scale efficiency of Islamic banking in the banking sector of Pakistan.

Shahid, ET. Al, (2010) examined the relationship between the

efficiency of conventional and Islamic banks of Pakistan the history of

conventional banks of Pakistan is very prosperous in comparison to the

Islamic banks. Islamic banking industry in Pakistan is in it’s easily stages

very few banks are operating in this sector which performs pure Islamic

banking. For this purpose we take a sample of five Islamic and five

conventional banks from 2005-2009. A data development analysis model

is applied to measure the efficiency of both banking sector under (ORS)

constant return on scale and variable return on scale approach. The data

source for the research for the research is the banking statistic of Pakistan

2004-2008 published by the state bank of Pakistan. This is an annual

report and all the financial data used for analysis are in term of Pakistani

rupees (in thousands). Information required for analysis of gives research

consists of five Islamic and five conventional banks based commercial

banks of the period of 2004-2008. The result shows that the technical

efficiency of conventional banks is better than the Islamic banks but in

cost efficiency both sectors show a health competition. The t-statistic

shows that there is no significant difference in means efficiencies scores

of conventional and Islamic banks except in year 2008.

Akhtar, ET. al, (2011) examined and analyzed the efficiency

and performance of Islamic banks as compare to two types of

conventional bank i.e. public and private sector banks in the case of

Pakistan. The literature review shows that no such type of method

has been used for Islamic banking in Pakistan before this study. It

will give clear understanding of the efficiency and performance of

Islamic banking to decisions makers. The nine financial ratios are

used under (I) profitability it liquidity risk and the credit risk to

measure the performance and efficiency. The financial statement

have been obtained of three types of banks from 2006-2010. The

bank includes public and private sector which is purely involved in

interest based banking system and third bank is Islamic bank doing

interest free banking. To analysis bank performance in Pakistan ratio

measures have been sued this methodology shows various positive

aspects.
 The secondary data is sued key advantage shows this method

removes the disparities. The banking firms are not in equal size. This

study concludes the efficiency of conventional and Islamic bank and

other banks of Pakistan. In ratios measure of Islamic bank regarding

return on asset and income generated per dollar is in between the

both types of conventional banks. The study concludes that

significant difference is observed in interest free and interest based

banking in respect of profitability.

Khan, Farooq and Fawad (2009) examined the performance of

Islamic bank in Pakistan is much better than conventional banks. He

pointed that he state bank of Pakistan granted permission to

conventional banks to open Islamic branches and windows that put

too much pressure and burden on newly established Islamic banks to

compete with them. The liquidity and solvency ratios are used in this

model. The four ratios are used to measure the profitability and

return on asset, profit margin, return on equity earnings per share.

These ratios indicate that the capital and dividends of the share

holder of Islamic banks are higher than the share holders’

conventional banks. The data from 2006-2009 has been collected

from state bank of Pakistan. Comparative analysis technique is

applied to compare operations and a product of both Islamic and

conventional banks from study 1st is concluded Islamic banks have

performed better than conventional bank in recent financial crisis.

They are as profitable as other conventional banks. One of the

reasons that Islamic banks are better that conventional is that Islamic

banks are financed more with equity and less with debt as compared

to conventional banks.

Ajlouni and Omari (2012) examined compare and investigate

the development of the relative efficiency of Jordian Islamic banks

performance over time 2005-2009. Using two different approaches.

Malmquist data envelopment analysis and financial ratio analysis.

There are three Islamic banks in Jordan one which has been

established recently 2010. The data used in this study are financial

information, extracted and analyzed from the balance sheets and

income statement which are available in the annual reports of the

banks. The study uses eleven financial ratios for bank performance.
These ratios are grouped under three broad categories, profitability,

liquidity and risk and solvency. There are three banks according to

Jordan Islamic banks, which are Jordan Islamic bank for investment

and finance, and investment Islamic international Arab bank and

Jordan Dubai Islamic bank. However, Jordan Dubai Islamic bank is

excluded from the study because it has been recently published 2010,

while the study sample covers the period to 2005-2009. The data has

been used and in this study is secondary data.

The results reveal that Jordan Islamic banks are constantly

efficient in term of their inputs producing actual outputs using both

approaches during the study period. However, the variation between

the sample banks is not significant. In addition there is no significant

evidence on the association between data envelopment analysis and

financial ratio analysis bank rankings it is recommended that Jordan

Islamic banks managers should increase their bank efficiency by

improving recourse utilization to produce optional outputs.

Said (2013) examined the correlation between risks and

efficiency within Islamic bank in the MENA area. This paper used
three stages of analysis. The first stage consisted of measuring the

efficiency of those banks by employing the nonparametric technique,

data envelopment analysis while second stage involved analyzing

risks by measure credit operational and liquidity risk using financial

rations. The third stage would be employing person correlation co-

efficient to examine the correlation between credits, operational

liquidity risks to efficiency for period 2006 to 2009.

The data which is used is secondary data which is obtained by

the financial data of Islamic banks for MENA banking from the

period of 2006 to 2009. The study results have revealed credit risk

has negative relationship to efficiency while operational risk has

found to be negatively correlated to efficiency too. The liquidity risk

should insignificant correlation to efficiency in Islamic banks in

MENA area.
 Jaffar and Manarvi (2011) examined and compared the

performance of Islamic and conventional banks operating inside

Pakistan. A sample of five Islamic banks and five conventional banks

were selected to measured and compare their performance. Each year

the average ratios were considered because some of the young

Islamic banks in the sample do not have five years of financial data.

The data collected from Islamic and conventional banks operating

inside Pakistan during 2005-2009 from SBP website by analyzing

CAMEL test standard factors such as capital adequacy, asset quality,

management quality earning ability and conventional banks. To

measure and compare the performance of Islamic and conventional

banks CAMEL analysis is used, which is standard test for

performance analysis of financial institutions and the latest technique

now a day’s used.

The study found that Islamic banks performed better in

possessing adequate capital and better liquidity position while

conventional banks pioneered in management quality and earning

ability. Asset quality for both modes of banking was almost the same,
conventional banks recorded slightly smaller loan loss ratio showing

improved loan recovery policy whereas, Uncoil ratio analysis

showed a nominal better performance for Islamic banks.

Ajmal and Tahira (2013) examined the performance of Islamic and

conventional bank in Pakistan. Twelve financial ratios were estimated to

measure this performance in term of profitability liquidity, risk and

solvency capital adectuacy. To determine the significance of mean

difference of these ratios independent sample t-test and ANOVAs was

used between and among banks. The audited financial statement income

statement and balance sheet both Islamic and conventional banks for the

period of 2000-2011 are used for ratio analysis. The ratios have been

calculated with the help of ratios formula. The other source sued for data

collection is SBP and business record data bases. The study concluded

that Islamic banks proved to be more liquid, less risky and operationally

efficient than conventional banks.

Basher (2001) examined the determinants of Islamic banks

performance across eight Middle Eastern countries between 1993 and

1998. A variety of internal and external banking characteristics were used

to predict t profitability and efficiency. In general our analysis of

determinants of Islamic bank profitability confirms previous findings. In

this study we use a set of variables. We use capital ratios leverage,

overhead, loan and liquidity ratios and foreign ownership as proxies for

internal measures. Mean while macroeconomics indicators, taxation

financial structure and country dummies are used as external measures. A

linear equation relating the performance measure to a variety of indicator

is specified. The data used in this study are a cross country bank level

data, compiled from income statements and balance sheet of 14 Islamic

banks each year in the 1993-1998 periods in eight countries. The main

data source is bank scope data base compiled by IBCA.

The estimation technique used is panel data methods and the while

1980 procedure is used to ensure that the co-efficient are hetroskedastic.

The results indicate that foreign owned banks are more profitable than

their domestic counter parts. Everything evidence that implicit and

explicit taxes affect the bank performance measures negatively.

Furthermore, favorable macroeconomics conditions impact performance

measure positively. Our results also show that stock markets are

complementary to bank financing.

Chapter 3

Theoretical Framework

Banks are financial institutions which contribute greatly to the financial

sector of any country. According to the act no; 10 of 1998 the definition of

banks can be described as;

‘‘Business entities that collect funds from the people in shape of

savings and allocate them to the public in form of the credit and or the
other forms in order to improve the living standard of the public’’

There are two types of bank in Pakistan;

(1)Islamic bank (2) conventional

1-Those banks who conduct their business activities acceding to the

conventional (conventional banks) which get profit and pricing to
consumer using the interest as the selling price.

2-Those banks who conduct their business activities or their business

activities based on the principles of shriah (Islamic banks) that apply the
rule of Islamic law based on the contract in the type of profit sharing.

The main focus of the study is the analysis of Islamic banking in Pakistan.
On the supply side the important component of growth of Islamic banking
is the increasing number of financial services institution contribution
shriah compliant solutions. In adding up the new Islamic banks that are
being started there is an increasing trend among present conventional
banks to change their operations according to the shriah complaint.
Moreover the markets of Islamic banking shows the rich potential. for the
purpose of analysis of the efficiency of Islamic banking we used input and
output variables.

the input variables are total deposits

,labor cost and share capital. while output variables are total
loan/financing, investment and net income after tax.

Total Deposits;
Money mostly kept in a banking institution for the purpose of safe
keeping. Bank deposits are mostly made deposits at a banking institution
like as saving accounts, checking accounts, and money market accounts.
The account holder has the right to withdraw these deposits according to
the terms and condition of the account which is set onward. The deposit
itself is like a liability which bank payable to the person who made this
deposit to the bank.

‘Total deposit is a expression which is integrated in the balance sheet of a

bank. commonly the world deposit is used for keeping the money safe in
a bank. When bank calculate the total deposits different types of deposit
come to the thought. These deposits are added jointly for the
determination of the total deposits. Various kinds of variables are added
for the sum up of total deposit such as demand deposits, terms deposits,
and interest and non interest bearing deposits are the increasing examples
that are added for the sum up of total deposits.

Labor cost;
The labor cost is the amount of wages and benefits which is given to the
employees according to the accounting period daily monthl indirect y or
weekly basis payroll and other taxes are also include in the labor cost.
Labor cost can be divided into two parts, direct and labor cost.

Share capital;
Total number of shares of a company that is kept by the share holders of the company
is called share capital. A company can issue the new shares at any time according to
his full amount of official share capital. The issuing of new share is also called
subscribed share capital. Authorized share capital mean the maximum value of
securities that the company can legally issue. share capita can also defined as a long
term financial investment by the share holder in a company.

Investment
An asset or investment that is purchased with this thought that it will give
income in the future. And from the economic point of view an investment
is the purchase of such things which is not consumed today with this hope
that it will bring income in the near future. And according to finance
investment is the purchase of monetary asset with this thought that it will
bring income and could be sold at high prices.

Net income after tax

According to the net income approach the change in the financial quantity
of debt of a firm will lead to the corresponding change in the weighted
average cost of capital &also the value of a company. according to the net
income approach the increase in the quantity of debt will decrease the
weighted average cost of capital and decrease the value of the firm.

Total loan
The essential amount of the loan plus any extra financed closing
costs called the total loan. The most ordinary type of loan comes
from the bank which exist to let somebody borrow so its number
disclosure that banks present a large variety of ways to fund the
business development.
Ch. 4
DATA&METHODOLOGY

I calculate the efficiency of five Islamic banks which are Al-

Meezan, Al-baraka, Burj, Islamic bank and Dubai Islamic bank.
The data for this study is obtained from every bank own website
and from annual reports of every bank. The data is obtained from
the 2008 to 2012. In which to check the efficiency three inputs
which are consist total deposits, labor cost and share capital and
three outputs which are total loans, investment and net income
after tax are used.
Input-output oriented measures
In order to measure the technical efficiency of any experiential input output bundles
we should know the maximum quantity of output bundles that can be produced from
the related input bundle. One possibility is to clearly identify a production function. The
values of this function at the input level under alarm represent the highest producible
output quantity. The more ordinary observe is to calculate approximately the parameters
of the particular input- function empirically from a sample output data. Because the least
squares method permits experiential points to lie above the fitted line, in a stochastic
frontier model one includes a composite error, which is a sum of a one-sided disturbance
term on behalf of shortfalls of the actually produced output from the frontier due to
inefficiency and a two-sided disturbance term representing upward or downward shifts
in the frontier itself due to arbitrary factors. For the econometric method requires one
must select a particular functional form (e.g., the Cobb Douglas ) out of a number of
alternatives. At the same input bundle x0 the value attained by f(x0) will depend on the
functional form chosen. Further, the parameter estimates are also sensitive to the choice
of the probability distributions specified for the disturbance terms.

Data Envelopment Analysis (DEA)

Data envelopment analysis (DEA) is a non parametric mathematical indoctrination
move toward to frontier estimation. I calculate the efficiency of Islamic banking with
the help of Data Envelopment analysis. By using this technique I calculate three type
of efficiency

(1) Technical efficiency. (2) scale efficiency (3) the combination of these two
efficiencies represent economic efficiency. This is also known as total cost
efficiency.

 A firm is said to be technically efficient if a it produce the maximum output

from the minimum quantity of input such as labor, capital and technology.

 Output at a scale that minimizes the profit of a firm where capital and
infrastructure can be set to maximize the level of profit called scale efficiency.

 Economic efficiency mean when the cost of production a given output is below
as possible.

This efficiency is calculated by a micro software which is known as (DEAP) by

version 2.1 introduced by central of efficiency and productivity analysis by the
university of New England in Australia. This Methodology introduced by Koopmans’s
in 1951.and then further demonstrated by Ceolli (1992).here I am using three inputs
and three outputs.

The constant return to scale

A production function exhibits constant returns to scale if changing all inputs by a
positive proportional has the effect of increasing outputs by the factor.

The variable returns to scale & scale efficiencies

If it is supposed that an increase in inputs does not result in a proportional change in
the outputs. And scale efficiencies mean output at a scale that minimizes the profit of a
firm where capital and infrastructure can be set to their profit maximizing levels.

Calculation of scale efficiencies

Many studies have stale the TE scores obtained from the DEA & CRS into two
components, one due to scale inefficiency and other due to ‘pure’ technical
inefficiency. This can be done by conducting the CRS & VRS, DEA upon the same
data. if there is a difference between the two TE scores of a particular DMU then it
indicates that the DMU has the scale inefficiency. And this inefficiency can be
calculated by the by the difference between the VRS TE scores & CRS TE scores.
Chapter 5

Results & conclusions

To analyze the efficiency of Islamic bank in Pakistan results and model are discussed
in this chapter.

Efficiency analysis of 2008

To analyze the efficiency of Islamic banks in Pakistan five Islamic banks have been
taken.

Table 5.1
VRS input oriented DEA analysis

Bank crste Vrste Scale

Meezan 0.612 1 0.612 drs
Al-baraka 1 1 1 _
Burg 1 1 1 _
bank islami 1 1 1 _
Dubai islamic
bank 1 1 1 _

According to the DEA Meezan bank is working according to the decreasing return to
scale.

 Decreasing return to scale mean when our inputs are increased by m and our
outputs are increased by less than one it’s called decreasing return to scale.

While other banks are working according to the constant return to scale .

 Constant return to scale mean when our inputs are increased by m, and our
output increased by exactly by m.

so through the Data envelopment analysis we come to know that the Meezan bank is
working according to the decreasing return to scale while other banks are working
according to the constant return to scale. so the result shows that the Meezan bank is
working inefficiently.

NOTE

 CRSTE=technical efficiency from CRS DEA

 VRSTE=technical efficiency from VRS DEA

 Scale=scale efficiency=CRSE/VRSTE

Table 5.2

Bank crste vrste Scale

Meezan 0.612 1 0.612 drs
Al-baraka 1 1 1 _
Burg 1 1 1 _
bank islami 1 1 1 _
Dubai islamic
bank 1 1 1 _

According to the table 5.2 technical efficiency of all the banks is constant.

 A firm is said to be technical efficient if a firm is producing maximum

output with the minimum quantity of inputs such as labor, capital &
technology.

The scale efficiency without the Meezan bank is constant while the
scale efficiency of Meezan bank is inefficient.

 Output at a scale that minimizes the profit for a firm where capital and
infrastructure can be set to maximize the profit of a firm.

Efficiency analysis of 2012

To analyze the efficiency of Islamic bank in Pakistan five Islamic bank have been
taken during the period of 2012.

Table 5.3
Bank crste vrste scale
Meezan 0.059 0.264 0.225 irs
Al-baraka 0.366 0.812 0.45 irs
Burg 0.676 1 0.676 irs
bank islami 0.767 0.906 0.847 irs
Dubai islamic
bank 1 1 1

According to the table first four banks have been working according to the increasing
return to scale while the fifth bank is working according to the constant return to scale.
The forth bank which is bank islami is more efficient from all the banks. There is a
clear result which come from the analysis is that according to the 2008 analysis all
banks were working according to the decreasing return to scale while according to the
2012 analysis all banks except Dubai Islamic bank is working according the increasing
return to scale. So the trend of Islamic banking among people clearly increased.

Table 5.4

Scale
Bank Technical Efficiency Efficiency
Meezan 0.264 0.225
Al-baraka 0.812 0.45
Burg 1 0.676
bank islami 0.906 0.847
Dubai islamic
bank 1 1

According to the table 5.4 the bank Islami is more efficient because the technical and
scale efficiency is greater than the Al-baraka because the technical efficiency of Al-
Baraka is 0.8 and scale efficiency of al-barka is 0.45 which is less than the bank
islami. But the Dubai Islamic bank is according to the analysis of 2008 and 2012 is
working according to the constant return to scale.

 When our input increased by m, and our output increased by exactly m,

it’s called constant return to scale.

Result & Discussion

The main purpose of the study is to analyze the efficiency of Islamic bank

in Pakistan .for this purpose five Islamic bank Meezan, Al-baraka , Burg,

Bank islami & Dubai islamic bank has been taken. I choose two periods for

the efficiency analysis which are 2008 &2012. For the efficiency analysis I

use three input variable and three output variables. The data for this

purpose has been taken from every banks own annual report from 2008 to

2012. To analyze the efficiency of Islamic banks in Pakistan Data

Envelopment Analysis have been used. According to the Data Envelopment

Analysis there is a clearly trend of increasing the efficiency of Islamic

banks because according to the 2008 analysis mostly banking was working

according to the decreasing or constant return to scale while according to

the 2012 analysis mostly banking are working according to the increasing

return to scale. Pakistan is an Islamic country so as a Muslim we should try

to implement & promote the Islamic banking system in Pakistan. Because

it’s our first and foremost obligation as a Muslim.

Ch. 6

POLICY & RECOMMENDATION

To increase the efficiency of Islamic banks we should follow these policies

& recommendation which is following

 Legal framework and support report have a positive effect on the

effective working of Islamic banking. Lack of legal frame work
maintains may slow down the process of banking.

 Sharing of knowledge is necessary for developing a successful

economic system. Knowledge sharing on Islamic banking issue is very
low. Hence this factor should be taken in the account analysis.

 The purpose of sharing knowledge is basically assisted to the research

and development efforts in Islamic banking & to reduce the expenses.
R&D are necessary for banks so that they could offer new services that
are ‘‘shriah complaints’’ in spirit.

 The public should be made aware of the cultural impact of the Islamic
banking system. They should be educated on the social benefits that an
Islamic banking system would have. They should be educated on the
social benefits that the society would gain from adopting the system.
Issues of poverty, basic public services in health, education etc. can be
addressed by sketch potency from such a banking system.

 (e) Political resolution may be regarded as the most important matter

from the supporters of self-governing school of thought. Beer (1981)
argues from his years of research on feasible System Model (VSM) and
Espejo and Harnden (1985) stress on the role of strategic and policy
issues in working of any system in business, non-profit and
Government organizations. Political dedication and leadership is
needed for developing the Islamic Financial System and distribution of
resources to authenticate governments resolve requirements to be sited
at the top.
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