Commercial Banks in Saudi Arabia - Dissertation Example

?Running Head: Research Proposal Research Proposal [Institute’s TABLE OF CONTENTS TABLE OF CONTENTS 2 INTRODUCTION 3 Significance 3 Research Objectives 4 Research Statement 4 LITERATURE REVIEW 4 RESEARCH DESIGN & METHODOLOGY 13 Research Questions 14 Research Plan 15 ETHICAL CONSIDERATIONS 15 CONCLUSION 16 REFERENCES 17 INTRODUCTION Since centuries, money has remained an important component of every human society, and has been a determining factor in deciding success or failure of an economy. In the past, there used to be elite existences that were responsible for maintaining inflow and outflow of money in the market; however, since few decades, commercial banks have been performing this imperative task to maintain and improve economy of the country. However, besides improvement of an economy, it is very important that commercial banks must look into their internal aspects and ensure fulfilment of their own objectives that is to achieve profitability that is the foremost and basic objective of every commercial organization around the globe. In this regard, while commercial banks play an imperative role in a country’s economy, they put efforts to ensure their own sustainability, as well as environmental sustainability that subsequently results in their own profitability. In this regard, there exist various determining factors that decide profitability of banking institutions, especially commercial banking organizations and it is important to analyze such factors. Significance In particular, it is an observation since the period of recession, a huge number of banking organizations are confronting problems in ensuring their profitability, and thus, outcomes of the proposed research will be effective in understanding different factors that play a crucial role in ensuring profitability in commercial banks. In addition, results of the proposed research will enable banking students to acquire a critical perspective of different processes of commercial banking that cause success or failure in terms of profitability, and therefore, understanding of the proposed research’s outcomes will be very significant in eliminating any adverse factors from the processes. At the same time, it will allow the potential bankers to give significance to factors that play a noteworthy role in guaranteeing profitability in the commercial banking industry. Research Objectives Before carrying out research, it is very imperative that the researcher ensures clarified understanding of aims and objectives, as it is an observation that vague objectives often result in unproductive outcomes, and thus, the research proposal will now include aims and objectives of the proposed research: Identify and examine different internal and external factors that play a crucial role in affecting the profitability of commercial banking organizations Scrutinize the extent of impact of such factors in different banking processes Study the effects of identified factors in the case study of a commercial banking organization in Saudi Arabia Identify and recommend strategies that may ensure positive impact of studied factors on profitability of commercial banks, specifically, in the corporate culture of Saudi Arabia Research Statement In this regard, the researcher will focus on the following research statement to fulfill the aims and objectives of the research: “To identify and analyze the factors that affect profitability of commercial banks, specifically, in Saudi Arabia” LITERATURE REVIEW Commercial banks are a key aspect in the financial growth as well as stability of nations. They are the main providers of funding for development ventures, credit and services for business dealings. They as well have an effect on money supply within the financial system through lending practices. Commercial banks in Saudia have shown record financial performance during the last five years, along with impressive economic development. The challenge for banking industry is to launch inventive ways in its functions leading to better financial performance. The mergers as well as acquisitions within the banking sector have resulted in large universal banks with respect to total assets and product diversification (Rose, p. 23, 2001). To a certain extent, financial performance relies on their capacity to adjust and function resourcefully within the new environment. The input of interest income to profitability was more contrasted. The yield on the loan book declined during the year 2008, and rose during 2009, revealing interest rate arrangements on the dollar, to which the Saudi riyal is attached. The result of interest rates on net interest margins was negative during both years after taking funding cost in consideration. During both years, Saudi commercial banks also made huge revenues from brokerage charges, on the back of the incredible increase in stock trading within Saudi Arabia (Williams, p. 90, 2010). Liberalization strategies launched within the commercial banks in Saudi Arabia led to secured competition, well-organized distribution of resources and initiating pioneering techniques for mobilization of reserves. The structural restructuring in banking sector is obvious in determination of rate of interest and alterations in prudential standards of the regulatory power (Flamini, pp. 39-47, 2009). All these would surely have inferences on competence as well as productivity of the banking sector in Saudi Arabia. It is a well-known fact that, a successful as well as resourceful banking system is vital for the long-term development and progress of the financial system. As a result, there is an impending requirement to make a comprehensive study into the functional competence as well as productivity of commercial banks. Saudi Arabia continued to progress with the Gross Domestic Product (GDP) estimated to have grown by ‘7.1%’ to ‘SR791.7bn’ (Sidawi & Meeran, p. 140, 2011) during the period of 2005-09. The rising oil prices along with the boost in production levels facilitate GDP growth, as the nation had to function at around ‘9.1mn bpd capacity’ (Sidawi & Meeran, p. 140, 2011) to retain constancy within the energy markets. The regulatory actions to improve economic activity are expected to create a firm foundation for continued growth of the financial system. The leading beneficiary is possibly the banking sector. During 2005-09, consolidated assets of the commercial banks raise at a ‘CAGR of 12.4%’ (Sidawi & Meeran, p. 140, 2011). The better competition within the banking sector will have effect on commercial banking segment, launching inventive products, going into new areas, innovative technology decreasing rate of interest as well as providing number of services at lesser prices with high quality. This will lead to more efficient competitive economy (Sinkey, p. 281, 2002). The profits of Saudi Arabia's twelve commercial banks continued to increase during 2009. As a group, the banks earned 1.62 billion US dollars in total net profits during the same year, which is the twelve percent from the 1.46 billion US dollar earned during 2008 (Lin, p. 93, 2009). Towards the last part of 2009, the collective size of the commercial banks' balance sheets had raised by 7.2 percent over year-end 2009 to 121.3 billion US dollar (Lin, p. 93, 2009). The net foreign assets of the commercial banks remained on 16.2 billion US dollar by the end of the year 2009 (Lin, p. 93, 2009), showing a cut from the 21 billion US dollar during the last part of 2009. Foreign assets of the banks were possibly repatriated during 2009 to assure expansion in domestic loan demand. The most important advancement within the banking sector was the merger of two of the 12 local banks. “Prince Al-Walid bin Talal, the major shareholder in both United Saudi Commercial Bank and Saudi Cairo Bank, merged the two banks into the new United Saudi Bank” (Rose, p. 74, 2001). The factors of commercial banks’ profitability are generally classified into internal and external factors. Return on asset, return on equity, return on capital employed and net interest margin are the dependent variables. The factors that get most consideration within the banking literature are ‘costs, asset and liability composition and size’ (Flamini, pp. 39-47, 2009). As a measure of bank costs, the capital ratio has been an important tool for measuring capital competence and should include the general security and reliability of commercial banks. It is a common understanding that well-capitalised commercial banks face lesser expected costs of financial crisis and this sort of gain will then be converted into high profitability (Lin, p. 93, 2009). A number of studies (IMF, pp. 19-50, 2004) reveal a considerable positive relation between asset size and profitability, and it is noted that commercial banks, which are capitalized well, are a lot more profitable as compared to other commercial banks. Asset size and liability composition ratios are also the important factors of commercial bank performance. Deposits and loans are known to be the most significant balance sheet signs as they signify a mark of conventionality of banking performance. In addition, commercial bank loans are also the most important source of revenues and are likely to have an effect on profits positively. Studies show that commercial banks with more ‘non loan’ earnings assets are more profitable as compared to those that depend greatly on loans. Commercial banks in Saudi Arabia are as well exposed to direct taxation via business tax as well as other taxes. Even though the tax rate on commercial profits is not an option for banks, yet the bank management should be able to distribute its investments to reduce its tax. In view of the fact that clients face an inelastic demand for banking services, most banks are able to put the tax weight on the clients (Harper & Arora, p. 129, 2005). Quite a lot of main milestone advancements took place in Saudi banking sector, which had an effect on its size as well as structure. From the establishment of the ‘Saudi Arabian Monetary Agency’ (SAMA) during 1952, which have an important part in the commercial banking in Saudi Arabia, the ‘Banking Control Law’ was passed during the year 1966 granting Saudi Arabian Monetary Agency (Harper & Arora, p. 129, 2005) the authority to manage loans, reserves as well as entry of banks. The ‘Saudization Act’ (Harper & Arora, p. 129, 2005) intended at shifting the mainstream of ownership of formerly non-Saudi banks to Saudi citizens was propagated. By the establishment of the United Saudi Commercial Bank during the yaer1983, the Saudization procedure was finished and the amount of commercial banking systems reached 12 with total branches of 926 during the year 1988 (Harper & Arora, p. 129, 2005). Profitability is generally assessed either by ‘the percentage of net profit (or net income) to capital’ or by ‘the ratio of net profit to total assets’ (Miller, p. 76, 1995). For the most part, studies that utilize the first measure of profitability consider ‘equity as representative of capital (or equity capital)’ that has come to be known as ‘return on equity’ (ROE). Equity capital takes account of all quantities invested by the owners of the bank (owner’s equity) in the shape of ‘stocks, paid capital or retained earnings’ (Gugler, pp. 23-28, 2008). Return on equity, as a result, offers a fine indicator of the rate of return the commercial bank is yielding to its owners. Nonetheless, it goes through the limitation of being restricted by the law by government authorities (SAMA in Saudi Arabia) on deposits as a proportion of capital, indicating an implicit link with size calculated by total deposits. A broader deflator of profits is required which is not directly correlated, by laws, to entire deposits and so to size. Return on assets (ROA) comes into help in view of the fact that assets consist of financial as well as physical assets, for instance, equipment and buildings. Since the majority of the commercial banks' actions signified by revenues and expenses are directly related to their total assets alterations in returns on assets reveal changes in profitability more precisely (Miller, p. 76, 1995). Competence is assessed either by the ‘ratio of net profit to revenue’ (Gugler, pp. 23-28, 2008), which is an sign of the way the bank holds its rate alterations in proportion to alterations in revenues, or by the ratio of service charges given by the bank to total deposits. It depicts the cost effectiveness of the bank’s consumption of ‘loan-able’ finances. Nonetheless, the costs incorporated in this measure are limited to those of loan-able finances and disregard other forms of banking costs such as administrative costs, which in a number of instances, may be a sign of development in the competence of banking functions, particularly taking into consideration the accelerating technical advancements taking place in the banking sector. Productivity is generally evaluated by the ‘ratio of loans to total deposits’. This indicator reveals the level of consumption of deposits by the commercial bank. It explains how far a bank is “loaned up” (Miller, p. 109, 1995). An increase in ratio indicates that a big fraction of ‘loanable’ finances is consumed, which represents consecutively low liquidity. Nonetheless, this measure of productivity in singling out loans since the consumption outlet for funds disregards the prospect of some of these finances being consumed either in getting foreign assets - such as securities - or investments - both local as well as overseas (Akhtar, p. 101, 2010). The amount of profit a bank earns works as an important factor in price movements. If the quarterly results are fine for a bank, then the price increases, and if the results are negative, the shareholders will show no interest in such bank’s share and as a result, price decreases. Shareholders invest funds in the banks that earn well and consecutively offer good ‘return on investment’. Therefore, an affluent as well as a profitable commercial bank have good shareholders and consequently have ‘positive price movements’. ‘Price to Earnings Ratio’ as well gives an idea regarding the same (Gugler, pp. 23-28, 2008). Usually individuals commit a blunder while estimating the bank’s value from the price of its stock. It is the market capitalization of the bank, instead of the stock price, that is more significant as it comes to finding out the value of the bank. In particular, “One needs to multiply the stock price with total number of outstanding stocks in the market in order to get the market capitalization of a company, which is worth of the company” (Williams, p. 133, 2010). As a result, bank with large Market Capitalization turns out to be more favourable for shareholders. Experts have indicated, “As market capitalization increases, the share price tends to increase and as market capitalization decreases, the share price tends to decrease” (Sinkey, p. 392, 2002). Price to Earnings ratio provides a reasonable idea of the way a bank’s share price in comparison to its earnings (Gugler, pp. 23-28, 2008). If the price of the share is a lot lesser as compared to the earning of the bank, the stock is underestimated as well as it has the potential to go up in the near future. Alternatively, if the price is way too high as compared to the real earning of the bank, then the stock is overestimated and the price can go down on any point. Interest rates play a key part in finding out stock market drifts. “Bull markets (those in an upward market) are usually associated with low interest rates and high Capital Gains, and bear markets (those in a downward trend) with high interest rates and low Capital gains. Interest rates are determined by the demand for capital - pushes them up and normally indicates that the economy is thriving and that shares probably expensive. Low interest indicate low demand for capital, thus liquidity builds up on the economy, driving share price down, and other interest rates like that of on Deposits and Borrowings also have impact on share price” (Lin, p. 67, 2009). The vigour of the international financial system has a basic influence on share prices, as it is ultimately responsible for driving profits of commercial banks. Generally speaking, if the financial system is progressing, banks profits progress and shares will become more highly valued. If the financial system is declining, banks profits will go down and share prices will drop. The development of the commercial banks has continued very quickly together with the parallel growth of the Saudi Arabian financial system. For instance, during 1968 there was only one bank functioning in the Kingdom of Saudi Arabia, but by the last part of 1986, there were ‘eleven banks with 628 permanent offices and braches’. The key role of commercial banks in Saudi Arabia is to offer as well as develop conventional short term services. Nonetheless, in the absence of specific medium-term services in the Kingdom of Saudi Arabia, commercial banks have been willing to help medium-term funding needs by revolving lines of credit to certain clients, with particular stress on industrial as well as expansion ventures. Private deposits represent the fundamental supply of finances for commercial banks, which usually do not give interest on current account credit balances. Savings accounts are supported by local banks. These accounts are a significant component of the entire deposits of bank. “As a result of the presence of the government specialized banks that enclose more or less every aspect of actions which can be done through the commercial banks, plus the increase of the time-savings, the commercial banks end up with huge amounts of money, and most of these deposits are invested abroad” (Harper & Arora, p. 201, 2005). Hence, the factors that affect the profitability of commercial banks are; F = F (i, e, g, b) Where: i = commission inside Kingdom of Saudi Arabia e = the discount commission b = interest rate in a foreign country g = specialized banks commission The commercial banks deposits with Saudi Arabian Monetary Agency have been greater than before mainly as a result of big outflows in expansion plans. Consequently, commercial banks started to straighten out their accounts by means of their surplus reserves instead of through cash payment (Kuhn, p. 59, 2006). The central bank made use of a number of fiscal policy instruments for this reason, together with fixing interest rates for commercial banks, which have been stayed close to equivalent dollar rates, the organization of overseas assets, as well as the introduction of short term and medium-term government policies for budgetary and balance of payments purposes and to level instabilities in domestic liquidity (Kuhn, p. 59, 2006). Saudi Arabian Monetary Agency also synchronized commercial banks, exchange traders, as well as moneychangers and has operated as the reservoir for all government finances; it paid out finances for purposes permitted by the department of investment and national financial system. The constant long-term development and improvement of the commercial banks in Saudia has been supported by a comprehensive system of banking regulation. SAMA has authorities to promulgate regulations, guidelines and instructions to banks in all areas, together with “capital adequacy, liquidity, lending restrictions, and credit and market risk” (Kuhn, p. 59, 2006). Moreover, it has the authority to carry out both on-site and off-site supervision. It operates as the supervisory body of the insurance market and has a double role of giving central fee and settlement services and for the supervision of these systems (Gugler, pp. 23-28, 2008). During last many years, it has applied its broad decision-making powers efficiently to guarantee that the Saudi commercial banks get benefit from a high standing for accuracy and constancy within the global financial markets. RESEARCH DESIGN & METHODOLOGY Besides acknowledging significance of objectives and research statement, it is very imperative that a researcher should give importance to methodology that plays a noteworthy role in facilitating researcher to acquire quality data and information related to the objectives of the research. From this understanding, this section of the research proposal will include description and discussion of selected methodology and design that will be enabling researcher to gather data. Particularly, it will be a qualitative study that will allow a wide-ranging understanding of the identified research statement. In addition, preliminary review of the literature has indicated that a huge number of experts and researchers have carried out studies regarding different factors that affect profitability of commercial banks in different parts of the globe, and literature review in this research proposal has even included observations and outcomes of various studies, which indicates the potential of secondary research methodology for the proposed research. Thus, the researcher will be carrying out secondary research method to identify more books, journals, articles, magazines, etc that will indicate the role of different factors that influence profitability of commercial banks in different parts of the globe. In this regard, the secondary method will enable scrutiny and analysis of data from abovementioned sources, and thus, will allow creation of a fundamental theoretical framework to achieve objectives of the proposed research. In this regard, focus on secondary analysis indicates possibilities of creation of new information based on scrutiny with the help of newer analytical tools and that will be very beneficial for students and professionals in better understanding of the identified research statement. For this reason, the researcher will be utilizing the tool of secondary research method. In particular, secondary research methodology will enable the researcher in focusing on a specific area, such as factors of profitability in commercial banks of Saudi Arabia rather than acquiring all the related information regarding Saudi commercial banks. In this regard, the researcher will put efforts to ensure analysis of available data and documents of Saudi commercial banks. In this way, the researcher will gain a more perceptive understanding of the factors of profitability of the commercial banks in Saudi Arabia. Concisely, the researcher will be taking an effective approach by utilizing the tools of secondary research method to fulfill aims and objectives of the proposed study. In brief, secondary method will facilitate the researcher in benefiting from efforts of other experts and researchers. Research Questions In particular, the researcher will focus on some of the following questions while carrying out secondary research methodology: What do you think affect profitability of commercial banks? Name any three internal factors that affect profitability of commercial banks? Name three external factors that affect profitability of commercial banks? What role do governmental policies play in profitability of commercial banks? Is performance effectiveness an evidence of profitability of commercial banks? In this respect, acquisition of data from different documents and resources will enable the researcher to add a broad perspective to the study in terms of theoretical and practical understanding of the identified aims and objectives. Briefly, secondary research method will be very effective in eliminating gap between theoretical and practical understanding of factors that affect profitability of commercial banking institutions. Research Plan # Phases Date Date Date Date Date Date Date Date Date Date 1 Theoretical Framework 1st week 2 Research Proposal 2nd week 3 Secondary Research 4-5th week 4 Analysis of Data 6-7th week 5 Primary Research 8-11th week 6 Distribution of Questionnaires 11th week 7 Collection of Questionnaires 12th week 8 Analysis 13-16th week 9 Rough Draft of Dissertation 17th week 10 Final Submission 18th week ETHICAL CONSIDERATIONS Understanding of different components of research has indicated that ethics play an important role in acquisition of productive outcomes, and it is very essential that a researcher should give significant importance to ethical obligations before, during, and after the research. In this regard, the researcher will be endeavouring effortlessly to ensuring confidentiality of acquired information from different resources and banking institutions. Moreover, the proposed research will include attempts of researchers to keep private information of different stakeholders classified, and only available for analysis to ensure fulfilment of ethical obligations during the research. Furthermore, the researcher will put efforts to keep personal information of employees of commercial banks secret, in order to ensure them confidentiality and privacy for the acquisition of truthful information during distribution of questionnaires. CONCLUSION To conclude, the proposed research is an effort of the researcher that will allow him to contribute effectively in the world of academia by fulfilling identified aims and objectives of the proposed research. In brief, the proposal included concise description of different components of the proposed research, in which researcher will be endeavouring to recognize and scrutinize factors that influence profitability aspect of commercial banks in Saudi Arabia. Conclusively, researcher anticipates that results of proposed research will facilitate students and potential bankers in critical and wide-ranging understanding of different factors that influence and affect profitability of commercial banks in different parts of the globe, especially in Saudi Arabia. REFERENCES Akhtar, Hanif. 2010. “Are Saudi banks productive and efficient?” International Journal of Islamic and Middle Eastern Finance and Management. Volume 3, Issue 2, pp. 95-112. Flamini, Valentina. 2009. “The Determinants of Commercial Bank Profitability in Sub-Saharan Africa.” IMF Working Paper. International Monetary Fund Press. Gugler, Klaus. 2008. The Economics of Corporate Governance and Mergers. Edward Elgar Publishing. Harper, M. and Arora, S. S. 2005. Small Customers, Big Market: Commercial Banks in Microfinance. Practical Action. IMF. 2004. Global Financial Stability Report. International Monetary Fund. Kuhn, J. 2006. Optimal Risk-Return Trade-Offs of Commercial Banks: and the Suitability of Profitability Measures for Loan Portfolios. Springer. Lin, H. 2009. IT and Efficiency Analysis in Commercial Banks and Insurance Firms. VTM Verlag. Miller, W. D. 1995. Commercial Bank Valuation. John Wiley & Sons Inc. Rose, P. S. 2001. Commercial Bank Management. McGraw-Hill. Sidawi, Bhzad and Meeran, Sheik. 2011. “A framework for providing lifelong finance to the owners of affordable dwellings in the Kingdom of Saudi Arabia.” Cities. Volume 28, Issue 2, pp. 138-146. Sinkey, J. F. 2002. Commercial Bank Financial Management. Prentice Hall. Williams, H. 2010. Building Type Basics for Banks and Financial Institutions. Wiley. Read More