Dynamic Paths to Islamic and Conventional Bank Cost Efficiency: When Size and Profit Collide in HIMI Economies

This study investigates the determinants of cost efficiency in Islamic and conventional banks operating in high-income and middle-income (HIMI) countries from 2015 to 2024, with a focus on the moderating effect of profitability on the relationship between bank size and cost efficiency. This study uses an unbalanced panel of 102 banks across 10 countries and employs a two-step system Generalized Method of Moments (GMM) approach. The results show that efficiency is persistent over time, indicating that past operational and governance practices have lasting impacts. Profitability directly improves cost efficiency and amplifies the benefits of larger bank size through economies of scale. Highly profitable Islamic and conventional banks demonstrate greater improvements in cost efficiency as their size expands. In contrast, banks with lower profitability experience only modest gains in cost efficiency as they grow. Higher credit risk reduces cost efficiency by increasing monitoring and compliance costs, while investments in intellectual capital are found to be vital for long-term competitiveness as it may slowly lower cost efficiency. Crisis periods are associated with higher efficiency, as resource constraints encourage tighter cost control. The findings provide important implications for policymakers, encouraging them to support efficiency without discouraging innovation and compliance. Finally, the study also lays out important implications for bank managers to strengthen risk management, strategically invest in intellectual capital, and leverage profitability to maximize the efficiency gains associated with the bank size.