In this paper we examine the performance of Bahrain as a leading financial center in the Gulf region. We estimate how close Bahrain banks are from their potential profits that a best-practice bank can earn and compare the profit efficiency of Islamic vs conventional banks. We employ the Fourier-flexible functional model to estimate the profit efficiency index.

Our findings show that the profit efficiency of Bahrain banks is relatively stable and in line with the OECD banks. In general, there is no much difference in profit efficiency between Islamic and conventional investment banks, despite the fact that many Islamic banks are small and act as venture capital. In contrast, the only Islamic commercial bank in the sample outperforms the conventional counterparts. This was due to lack of competition whereby the Islamic commercial bank was able to reduce inputs costs and charge higher mark-up.

In order to sustain Bahrain’s position as a leading Islamic financial center and meet the challenges of liberalized global financial market, two strategic policies have to be considered: First, small Islamic investment banks have to consolidate aiming for a greater market share, reducing foreign competition and gaining services delivery advantage. This issue is of immediate concern. Second; lack of competition hindered the development of the Islamic commercial banking in Bahrain. The BMA has to encourage a broader base of Islamic commercial banking in Bahrain in order to absorb the increasing demand on Islamic financial services and products. The BMA has to encourage reputable financial institutions, which can provide comprehensive range of Islamic financial services, to operate in the market.