Interest Rate and Financial Performance of Banks in Saudi Ariba (Essay Sample)

INTEREST RATE AND FINANCIAL PERFORMANCE OF BANKS IN THE KINGDOM OF SAUDI ARABIA NAME ADMISSION NUMBER A RESEARCH PAPER SUBMITTED TO THE UNIVERSITY OF … FOR THE PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE IN … OF THE UNIVERSITY OF … MAY, 2023 1. Introduction The banking sector is an important sector in Saudi Arabia that plays a fundamental role in the economy by mobilizing diverse resources, alleviating poverty, and controlling all the public finance. The sector in Saudi Arabia is controlled and regulated by the Saudi Arabian Monetary Authority which oversees eleven local commercial banks and about twenty branches of foreign banks in operation in the country. The efficiency of the banks in Saudi Arabia are dependent on the policies which have been put in place such as the fiscal policies and monetary policies. The interest rates fluctuations in the Kingdom of Saudi Arabia can have significant effects on its economy. It is therefore imperative to understand the impact of interest rates on financial performance of commercial banks in Saudi Arabia through various variables for example return on assets, return on equity, earnings per share among other variables that show the relationship between interest rates and financial performance. Interest rates largely plays a significant role in banking sectors as they impact both the demand for and supply of the loans and deposits by and in the commercial banks. Interest rates equally influences the cost of financing, which to a large extent impacts the profitability of the commercial banks. In the Kingdom of Saudi Arabia, interest rates are set by the Saudi Arabian Monetary Authority and have a significant effect on financial performances of banks in the economy. The issue of interest rate fluctuations in the world economies more especially in Saudi Arabia calls for a thorough investigation to establish the effect interest rates have on the financial performance of the banking institutions. If the interest margins of banks increases, the banks stand to benefit, but the increase has a significant negative effect on both the borrowers and the lenders. Over the past few years, there has been an increasing trend interest margins of banks in the Kingdom of Saudi Arabia, which has further been exacerbated by a lack of opportunities which are desirable for the banking institutions. It is worth noting that the changes in the interest rates affects both the cost of capital and also influence consumption levels among individuals. Increase in interest rates increases the cost of capital hereby affecting investments in the economy, whereas a decrease in the interest rates reduce significantly the rates for the bank depositors thereby suppressing the amount of savings in banks which the banks can loan out to borrowers to earn some income. Therefore, it is important to note that any changes in the interest rates in an economy have repercussions both on the banking institutions and by extension on the whole economy. Unlike other organizations, banking institutions are highly sensitive to changes in the interest rate, and overall their income of the banking institutions are highly impacted by changes in the interest rates. Frequent changes in the interest rates affects the financial performance of banks (Claessens, Coleman & Donnelly, 2018). The effect of the fluctuations in interest rates in the Kingdom of Saudi Arabia remains an important that ought to be investigated to unravel the effect of such fluctuations on the financial performance of banks. The research study was based on the secondary data collected from the various financial statements of the commercial banks operating in the Kingdom of Saudi Arabia. The data was analyzed using SPSS software. The findings of the research are largely expected to provide useful insights into the effect of interest rates on the financial performance of the commercial banks in the Kingdom of Saudi Arabia. The research is useful for policymakers, bank regulators, and banking professionals to understand the effect of interest rates on the financial performance of the banking sector in the Kingdom of Saudi Arabia and the interest rates risk can be managed effectively. The Kingdom of Saudi Arabia is one of the largest economies in Middle East and North Africa region, the MENA region, with a GDP of approximately $793 billion as at 2020 (Amoatey et al., 2021). The banking sector is an important component of the Saudi Arabian economy, since it provides financing to all sectors both the private sectors and the public sector. The banking sector comprises of the commercial, investment, and Islamic banks, as well as foreign banks. Over the past century, the banking sector in Saudi Arabia has witnessed tremendous growth and development, with establishment of many local banks as well as foreign banks. The role the banking sector plays in any economy in facilitating economic development cannot be underestimated. Therefore, efficiency in the banking sector is an issue that ought to be looked into by establishing the effect of interest rates on the financial performance of the banking institutions. The Saudi Arabian Monetary Authority is tasked with the responsibility of putting in place the monetary policies and interest rates in the economy. Interest rates affects both the demand and supply of loans and deposits. High-interest rates largely increases the cost of borrowing, which to a large extent affects the borrowers who are seeking loans. However, low-interest rates largely stimulates the demand for loans, but decreases interest incomes which commercial banks earn on their assets thus affecting their financial performance. Equally, the interest rates also affect cost of funds, which affects the profitability of the commercial banks. The financial performance of the commercial banks is an important aspect of the banking sector in economy since it reflects the ability of the commercial banks to generate income and manage various risks (Alemu & Aweke, 2017). The financial performance of the commercial banks can be measured by the use of proxies which include return on assets, return on equity, net interest margin, and efficiency ratio. These proxies which represent financial performance of the commercial banks are affected by the interest rates and other risks such as the credit risks and interest rates risks. The commercial banks are largely exposed to the interest rate risks as a result of the maturity mismatch between their liabilities and assets. Banks are largely faced with the challenges of managing credit and their profitability as a result of the negative effect interest rate volatility has on their financial performance (Baum, Mustafa, and Neslihan, 2009). The volatility of interest rates can be attributed to macroeconomic policies which are largely ineffective, for instance excessive spending by the government, high inflation levels, and overvalued rates of exchange rates in the foreign market. These distortional policies are at times implemented intentionally, as government officials perceive high levels of interest rates, inflation, as well as high exchange rates can contribute towards improvement in the performance of the economy. It is important noting that the financial performance of banks is not largely taken into considerations when such macroeconomic policies are formulated. The impact of the volatility of the interest rates in Saudi Arabia over the past decade is still unclear and understudied (Aloui et al., 2018). The study was...