Systematic Risk, Macro Financial Linkages, and Stress Testing: Evidence from the Emerging Economy

Abstract

This paper develops a comprehensive macro stress-testing (MST) framework to evaluate the resilience of Saudi Arabia’s financial sector against systemic risk over the period 2010–2025. The approach integrates macro financial linkages, credit risk modeling, and scenario analysis to simulate the impact of severe but plausible shocks on capital adequacy ratios (CAR) and capital shortfalls. Using Saudi macroeconomic data, the study demonstrates that GDP growth and oil price fluctuations are dominant drivers of systemic risk, while inflation and unemployment exert significant but secondary effects. Under severe adverse conditions, the banking sector’s aggregate CAR declines to 9.6%, requiring an estimated capital injection of 3.7% of GDP. The findings underscore the strength of Saudi Arabia’s financial buffers, while emphasizing the importance of dynamic capital buffer calibration, sectoral diversification, and cross-border macroprudential coordination within the GCC. Policy recommendations are provided to enhance stress-testing governance and fiscal and financial alignment. The findings highlight the importance of dynamic counter-cyclical capital buffers, sectoral diversification, liquidity resilience, and enhanced fiscal–financial coordination. Policy recommendations are provided to guide SAMA and the Financial Stability Council in capital planning, stress-test governance, and macroprudential policy design.