Oil prices and determinants of bank profitability in Saudi Arabia : a comparative study

Abstract

Efforts have been made by the Saudi Arabian government for economic reform to bring about an economy driven by the private sector rather than a full reliance on oil sector. This study seeks to comparatively analyze the profitability determinants between conventional and Islamic banking sectors and the influence of oil price changes on their profitability for the 2008-2014 period. The sample size comprises of twelve domestic banks that are commercial in nature - four Islamic banks and eight conventional banks. The primary objective of this research paper is to examine the impact of internal factors such as bank characteristics, and external factors such as macroeconomic conditions on the profitability of the Saudi Arabian banking industry. The analysis consists of descriptive statistics comparisons and ordinary least square for both sectors. The descriptive statistics reveal that the conventional banks perform better than the Islamic banks in terms of utilizing their assets. The ordinary least square results show that bank size exhibited a positive coefficient and a significant impact with both the conventional and the Islamic banks. Bank size is the only variable to demonstrate a significant impact across all regression models of the Islamic banks. Capitalization and credit risk variables indicated a significant influence on the profitability of the conventional banks. The empirical findings suggest that macroeconomic indicators such as inflation and gross domestic product (GDP) growth have no significant impact on profitability. As for oil price changes, the results show a significant impact on the profitability of the conventional banks. However, oil price changes did not result in significant impacts on the Saudi Islamic banks. Through this observation, it can be reasoned that Islamic banks are not dependent on the oil sector, which perhaps indicates their inclination towards achieving Saudi Arabia’s economic reform objective of building true wealth through non-oil related investments.