SAUDI ARABIAN COMMERCIAL BANKS’ MARKET-RISK SENSITIVITY: LITERATURE REVIEW

SAUDI ARABIAN COMMERCIAL BANKS’ MARKET-RISK SENSITIVITY: LITERATURE REVIEWThe Saudi banking sector consists primarily of 12 domestic participants, 11 of which, except National Commercial Bank, are listed on the stock exchange. Saudi banks command a conservative balance sheet structure with around 10% of balance sheet in form of ready liquid assets, around 55% of the assets in private sector claims, primarily private sector loans, around 15% of assets in public sector claims, majority of which consist of government and quasi government debt. Public Sector debt forms only a small 2% of the total assets. The banks have a conservative funding profile compared to their GCC members with 70% of total assets funded be deposits, 14% of total assets funded by equity and no significant reliance on wholesale funding (Aserkoff, Kern, & Dixit, 2012). further
Currently there are four Islamic banks listed on the TASI. The remaining banks are conventional banks whichalso offer Islamic products. Islamic banks are not only the major source of Islamic banking products, but also offer a variety of banking services such as foreign exchange, business, money transfers, documentary trade finance, portfolio management and underwriting of capital market issues.Islamic banks listed on the TASI represent 42% of the banking sector, Al-Rajhi Bank 34%, Alinma 4%, Bank AL-Jazira and Bank Al-Bilad 2% each. Conventional banks represent 58% of the banking sector, Samba Financial Group 13%, Riyad Bank 11%, Saudi British Bank 10%, Banque Saudi Fransi 10%, Arab National Bank 8%, Saudi Hollandi Bank and Saudi Investment Bank 3% each. Collectively the Saudi banking sector represents a very strong reservoir of liquidity within a world of financial drought, economic stagnation and political instability.
In 1990, William Sharpe won a Nobel Prize in Economics for his work in developing the CAPM. Traditionally the CAPM has been the basis for calculating the required return to the shareholder. In turn this figure has been used to calculate the economic value of the stock and the Weighted Average Cost of Capital (WACC) for capital budgeting. Black, Jensen, & Scholes reported the first notable test of the CAPM. Their methodology was mainly a time series regression framework. The CAPMstates that the expected return of any capital asset is proportional to its systematic risk measured by the beta. Fama & Macbeth further tested the cross section relationship implied by the CAPM. They found the risk premium for beta is positive and the average return on the asset uncorrelated with the market is equal to the risk free rate of interest. In the first step of their two pass procedure the risk variables are estimated via a time series regression of the excess asset return on the excess markets return. The subsequent monthly returns on the asset are then cross-sectionally regressed on the risk variables estimated from previous data which provide the estimates of the risk premium. The empirical evidence suggests that the relationship between average asset returns and the beta was positive, but not too strong. To test the model implication that beta is the only relevant risk variable, they also included the squared beta and the residual variance as explanatory variables. These variables did not significantly improve the explanatory power.

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