Abstract

The main objective of this paper is to measure and decompose changes in total factor productivity (TFP) and efficiency of banks operating in Pakistan. We apply the intermediation approach to empirically assess the change in productivity and efficiency of banks over the period 2007-2013 and observe whether the TFP and efficiency of banking sector have been increasing or decreasing over time. Specifically, the DEA-based Hicks-Moorsteen TFP index proposed by O’Donnell (2010b) is used to decompose the TFP into technological change, technical efficiency, mix efficiency, and residual scale efficiency. The paper also aims at comparing changes in TFP and efficiency of Islamic banks with that of their conventional counterparts. The estimates suggest that the TFP of both conventional and Islamic banks was on the rise during the period of study. However, we find that the TFP of conventional banks is higher than that of Islamic banks in most of the examined periods. The results also reveal that changes in technology have a significant positive impact on the TFP of both types of banks. Finally, the analysis suggests that scale efficiency has a vital role for efficiency progress in the banking sector. This evidence suggests that Islamic banks would need to increase their size to harvest sustained productivity gains. Growth-oriented polices and large branch network would definitely help Islamic banks to enhance their productivity. Further, government should encourage banks to adopt new cost effective technologies to help the banking industry in overcoming the problems relating to inefficiency and to further increase the productivity. The originality of the paper rests on its various important contributions.

Keywords

TFP; Technical Efficiency; Mix Efficiency; Residual Scale Efficiency; Hicks-Moorsteen TFP index; Conventional Banks; Islamic Banks; Pakistan.