banking in Saudi Arabia



The banking sector in Saudi Arabia has its various challenges, but it is generally stable and the Bank of Saudi Arabia controls it as a regulator of monetary policy. The banking sector continues to play the main role in financial intermediation in Saudi Arabia, with a structure that has remained unchanged in recent years consisting of several private equity banks and dominating foreign-owned banks with Different worlds different. For the financing of the activity, the main factor remains the deposits, which account for about 82.1% of all liabilities of the banking sector. An efficient asset management with an expected return of solid capital dominate the banking sector’s profitability in Saudi Arabia. The banking sector’s vulnerable challenge in Saudi Arabia is prevalent in the cost of interest rates and FPS and DPS. This paper will be organized to include an introduction in the first chapter, followed by the review of literature related to the subject in the second chapter, the methodology of the paper and the working hypotheses in the third chapter, the econometric model in the fourth chapter, the results and the interpretation of the economical model in the fifth chapter, and last chapter will discuss conclusions drawn based on the findings.

banking in Saudi Arabia

  1. Literature Review


Papers in the field of return on equity through the DuPont model are oriented to two problem-solving segments, some focus through the financial analysis of the model, which are interpreted only as a percentage, while the rest focus through the econometric model.

Professor Ramesh [7] states “the DuPont model is made up of 3 important components, from profitability, operational efficiency, and leverage”. This author [7], who has studied banks in India, states that is a factor in return on equity, ROA, as asset management is better than banks, since banks’ ownership is predominantly foreign-owned, and that they have easier management, due to the tradition in this sector. One of the more useful measures of the financial performance of a company is the DuPont Equation. This model allows the stock analyst, as well as the investor, to examine the profitability of a company using information from both the income statement and the balance sheet [1, p.58].

Business people generally refer to profit, which is defined as the amount available for capital or ownership position after payment used by the company, as the accounting income or business income. Meanwhile, the economists define income as the rest of the revenue (R) minus explicit and implicit costs (C) at the cost of doing business. The normal rate of return on capital is the minimum rate of return necessary to attract and retain the investment for a particular use [2, p.1950].The most dominating among these institutions are the banks, which provide services and employment to large strata of the population and perform the twin role of delivering an infrastructural base for other business to prosper and leading as commercial institutions that offer their shareholders with a high ROE. With the collapsing of major banks all over the world the trust ability of the financial statements of the same has become questionable both from an economic and social point of view [3, p.64]. Factor affecting return on equity (ROE) in the banking sector of Saudi Arabia through the DuPont .. DOI: 10.9790/487X-1911033034 31 | Page

The profitability of the banking sector has improved significantly in the first seven years of the new millennium before the crisis start up. This was in result of the general reform of the banking system (write off of non-performing loans, privatization of state-owned banks, the introduction of modern banking techniques, credit expansion, and the introduction of the euro) and the high intermediation spread in these countries.In the future, the financial institutions should find different sources of profitability, since the intermediation spread is expected to fall as the economies stabilize ; as the interest rates fall and the competition among banks increases. The financial institutions should seek for these new sources of profitability in retail banking and asset management, while they should try to increase their market share. On the other hand, they should also control their operating expenses and expand their activities quite carefully, in order to minimize their losses from bad loans [4, p.163]. The model created by F. Donaldson Brown,[INSERT], who came up with it when he was assigned to clean up the finances in General Motors and has ever since been an important factor for financial analysis. Remarkably it has not been used in the security community for risk prioritization or impact analysis. An engineer at DuPont, who was charged with understanding the finances of a company that DuPont was acquiring, developed the original DuPont method of financial ratio analysis in 1918. He noticed that the product of two often-computed ratios, net profit margin and total asset turnover, equals the return on assets (ROA) [5, p.85]. In addition, bankers, decision makers, and researchers can use the same model to determine and assess the value of these banks and estimate the expected value of future cash flows. Many studies have been carried out in the literature on financial performance, but financial analysis on banks in Saudi Arabia is limited, so this study can be a source of help to different groups such as bankers, academicians, and stockholders [6, p.84].

2.2. DuPont models

The DuPont model is a financial analysis tool, consisting of two influencing elements, ROA (return on assets), and EM (equity multipliers). ROE (return on equity) is the best indicator to see how the equity capital of a firm or other financial institution has increased or decreased. The DuPont Corporation created the DuPont model in 1920 [7]. Today there are two variants of this model, the first with 3 steps and the second with 5 steps. We will discuss the first 3-step model for ROE calculation.

2.3. Net profit margin

The net profit margin of a firm shows how much profit it generates from the sale of short-term assets. Net profit margin depends on competition. In a low-end competitive market, it will be a bad indicator for the company to have a low profit margin, while the company with a high profit margin shows that they have a premium product or service. Net profit margin differs from firm to firm. It is therefore important to compare the financial reports of different firms in the same industry (ROE).

2.4. Return on assets (ROA)

ROA is a measure of profitability that shows how the bank carries out services in relation to its full potential. Return on assets measures net income in relation to total assets. This report shows the return on all bank assets after interest and taxes have been paid. Also, this report shows how well a bank is managed as it shows how much profit is generated on average for each asset unit. The return on assets is a much-used report in empirical capital adequacy analysis as it allows comparison between banks of different sizes.

2.5. Capital multiplier

The most recent and important component of the DuPont model is the capital multiplier, which shows what benefit it will be from the debt to finance its wealth. A higher multiplier coefficient shows high leverage, which means that the firm relies more on borrowed loans to finance its wealth. The institution can increase its ROE by increasing the capital multiplier. However, if a company already has a high leverage, taking additional loans will create a situation for not being able to meet the obligation to creditors and the firm may eventually go bankrupt.


III. Research Methodology


To estimate the factor influencing return on equity (ROE), we will rely on quantitative methods, such as multivariable regressive. A secondary data source is used, such as timestamp data. Time series data are annual, from 1996 to 2014, so there are 18 time series observations. The multi variables regression model will be used to explain which independent variable will affect the dependent variables. The “p-value” coefficients of the explanatory variables used in order to test the hypotheses in the model are of 1%, 5% and 10% significance. Factor affecting return on equity (ROE) in the banking sector of Saudi Arabia through the DuPont .. DOI: 10.9790/487X-1911033034 32 | Page


  1. Hypotheses


This paper’s hypotheses are based on the econometric model: H0 – Return on assets (ROA) does not affect return on equity (ROE); H1 – Return on assets (ROA) affects return on equity (ROE); H0 – The capital multiplier does not affect the return on equity (ROE); and, H1 – The capital multiplier affects the return on equity (ROE).


  1. Empirical Data And Hierarchical Multivariate Regression


The multipurpose regression model for the DuPont model is built on a linear system. While many different authors have modified this model, the work outlined in this paper will be based on the model built by Tallinn University of Technology [8]: ROEt= C + β1ROAt2EMt + ε Where; ROEt- Return on equity, measured for: ROE = (Net income) / (Share capital) x 100 ROAt- Return on assets, measured for: ROA = (Net income) / (Average assets) x 100 EMt – Equity multiplier, measured for: EM = (Total assets) / (Share capital) x 100 C – Constants for variables Ε – random error for period t T – 1996 to 2014


  1. Results And Discussion Of Analysis


To overcome the econometric model data, we used the SPSS statistical program. Based on calculations of the econometric model, the results obtained show that the dependent variable has a strong correlation with the explanatory variables at the level of .993 (99.3%), while R2 in this analysis is .985, which indicates that 98.5% of the dependent variables are explained by independent variables. The adjusted R2 is equal to .983, which indicates that 98.3% of the variance of the dependent variable is explained by the variation of independent variables. Serial correlation was used in this analysis for verification of model stability. The Durbin-Watson correlation value may be in the range of 0 to 4. If the value of Durbin-Watson is approximately zero, then the serial correlation indicates that the data in the model has a high positive impact between the residual value. If the Durbin-Watson correlation is offered a value of four, it indicates that the data has a negative serial correlation. The model can be considered stable when the Durbin-Watson results are close to the value range of two. The Durbin-Watson test is considered to have no serial correlation within the range of 1.5 to 2.5, indicating that the residual value has no serial correlation or that there is no autocorrelation between the residual value. Therefore, based on this interval, the findings in this study show that the Durbin-Watson value is 1.577, which is within the range value, and consequently the model is stable. Table 1.Model Summary

Model Summaryb
Model R R Square Adjusted R Square Std. Error of the Estimate Change Statistics Durbin-Watson
R Square Change F Change df1 df2 Sig. F Change
1 .993a .985 .983 1.0794481 .985 528.364 2 16 .000 1.577
a. Predictors: (Constant), EM, ROA
b. Dependent Variable: ROE


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