Performance and profitability of islamic banks in Saudi Arabia: An empirical analysis

Abstract

The Present study examines all the internal and external determinants contributing the profitability of 9 Islamic Banks in the region of Saudi Arabia over a period of 2000-2013, that is a period of 14 years. During this period the region of Saudi Arabia has witnessed structural changes as it enters into WTO membership. Also, the period is sufficient enough to see to effects such major changes happened in the region over the financial intermediaries. Using the unbalanced panel data and robust fixed effect model of regressions, the paper examines the impact of bank specific, industry specific and macro-economic variables on profitability. Results indicate that bank characteristics, industry characteristics, and macroeconomic variables are significant in determining Islamic banks’ profitability. Our empirical findings indicate that the coefficient of the capital adequacy is positive and highly significant, with both the measures of profitability, reflecting the sound financial condition of Saudi banks. On the other hand, the positive and significant leverage ratio implies that the Saudi Islamic banks are relying heavily debt financing, suggesting that Saudi Islamic banks are more risky in nature, though profitable to a certain extent, but these might be badly hit in times of recession in the economy. Thus, diversified portfolio is necessary to maintain stability in the future and to reduce the risk and uncertainty. The findings relating the industry specific variables, we find that banking sector in Saudi Arabia is highly competitive. The study further emphasizes optimal policies to bank management that helps the policy makers, bank managers and executives in improving the overall efficiency and maintaining the sound profitability in the Islamic banks in Saudi Arabia.