1

Labsca Thesis

Factors Affecting Financial Performance of

Banks in Saudi Arabia using Camel
Framework.
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Table of Contents
CHAPTER 1 ........................................................................................................................................... 4

INTRODUCTION ................................................................................................................................... 4

1.0 Project Background ............................................................................................................... 4

1.2 Background of the Study ............................................................................................................. 5

1.3 Broad Problem Area .................................................................................................................... 6

1.4 Problem Statement ...................................................................................................................... 7

1.5 Significance of the Study.............................................................................................................. 7

1.6 Study Objectives .......................................................................................................................... 8

1.7 Research Questions ...................................................................................................................... 8

1.8 Conceptual Framework ............................................................................................................... 9

1.9 Study Hypothesis ......................................................................................................................... 9

1.10 Scope and Limitations of the Study ......................................................................................... 10

CHAPTER 2 ......................................................................................................................................... 12

LITERATURE REVIEW ...................................................................................................................... 12

2.1 Saudi Arab Banking Industry ................................................................................................... 12

2.2 Financial Performance............................................................................................................... 15

2.2.1 DV1: Stock Return ................................................................... Error! Bookmark not defined.

2.2.2 DV2: Profitability ................................................................................................................ 18

2.3 Theoretical Framework ............................................................................................................. 21

2.3.1 Modern Portfolio Theory .................................................................................................... 23

2.3.2 Resource-based Theory ....................................................................................................... 24

2.3.3 Arbitrage Pricing Theory.................................................................................................... 25

2.3.4 Management Theory of Frederick Taylor .......................................................................... 26

2.4 CAMELS Framework ............................................................................................................... 26

2.4.1 Capital Adequacy ................................................................................................................ 27

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2.4.2 Asset Quality ....................................................................................................................... 27

2.4.3 Management Soundness ...................................................................................................... 28

2.4.4 Earnings .............................................................................................................................. 28

2.4.5 Liquidity .............................................................................................................................. 29

2.4.6 Sensitivity ............................................................................................................................ 29

2.5 Determinants of commercial banks’ financial performance .................................................... 29

2.5.1 IV1: Bank Management Efficiency (Internal Variable) .................................................... 29

2.5.2 IV2: Bank Earnings Ability (Internal Variable) ................................................................ 32

2.5.3 IV3: GDP (External Variable) ............................................................................................ 34

2.5.4 IV4: Inflation Rate (External Variable) ............................................................................ 35

2.5.5 IV5: Interest Rate (External Variable) ............................................................................... 36

2.5.6 IV6: Oil Price (External Variable)..................................................................................... 37

2.6 Summary .................................................................................................................................... 38

2.7 Literature Matrix....................................................................................................................... 40

References............................................................................................................................................. 57
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CHAPTER 1

INTRODUCTION
1.0 Project Background
Well-functioning financial sector contributes significantly towards economic growth by
providing positive avenues to other sectors within the economy, which ultimately affects the
people’s living standard within the country. Sound banking system within the country enhances
efficiency and allocation of resources, which stimulates economic growth (Ragonmal, 2015).
Commercial banking is a vital segment in the sector of financial services in any economy of any
nation all around the globe. Economies develop and expand due to several factors but the financial
intermediation function of the banks is one of the most important for economic development and
progress of countries through fund channeling from depositors to investors continuously.
However, for banks to continue performing this role or function in the economy they need to be
stable and beyond the sustainable intermediation function means to be profitable by generating the
necessary income to cover the operational costs they endure while doing their role (Knight,
Hossain, & Rees, 2009). Role of commercial bank is to effectively manage various risks, which
includes solvency risks, credit risks, systematic risks and market risks, in order to provide long
term capital which is pre requisite for economic stability and development (Paavo, 2017).

Bank financial performance is usually measured by determining the profitability of the

bank. Banks profits are generated from the fees charged over the services they provide and the
interest value excised on assets while the expenses incurred by the bank are the interests they pay
on their liabilities every financial year. The main assets or services of a bank that attracts revenues
include loans to individuals, companies, and other institutions and securities the bank holds. On
the other hand, the liabilities for a bank institution include deposits and the funds borrowed from
other banks or through selling of commercial paper in the money market. The financial
performance of an institution is used to track and review a firm’s progress against its strategic plan
and goals as discussed by Kariuki (2013), Kang and Kinyua (2016). Steven and Gray (2015) stated
that the financial performance of an institution is a strong index that influenced perception of
satisfaction and value. Stakeholders in the banking industry in Saudi Arabia same as academic
researchers have been always interested in studying the topic of financial performance in the
banking industry. This is because the financial performance in fact has a pivotal effect and
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implication for the economic growth in any country. Nazir (2010) stated that the financial
performance of a banking firm could be measured using the CAMEL framework, which includes
the capital adequacy, asset quality, management capability, and earning analysis. Profit
management is the strategic planning for the financial undertaking within the organization.
Financial reporting is a hot discussion topic among the stakeholders of the firm. The level of profit
is a crucial assessment measure for performance.

Profit management is the outcome of agency theory based on this, the interests of owners
and managers contradicts. Banks are prestigious monetary institutions that attract allocate peoples’
funds for the business. For assessing the performance of banks, various measures are presented,
but the CAMELS framework is the most effective way to gauge the performance of banks.
CAMELS is the assessment model for the non-bank and bank credit institutions that investigate
and give values to the financial and management performance fields (Liu & Pariyaprasert, 2014).

1.2 Background of the Study

Stock markets are valuable tools for the financial progress of the country. Sufficient stock
markets pool deliver private funds and use them for the business investment. Stock markets give
them admittance to inexpensive capital than traditional bank finance. It also assists them in
mitigating business risks. For thriving the market, robust supporting architecture is crucial that are
mostly inadequate in the emerging markets. The foreign investments are the catalyst for the
development of emerging market bourses. The market capitalization was about 313 billion US
dollar in 2015, and the following largest country was Kuwait having a market cap of 94 billion US
dollar. The Tadawul market cap was about 67% in 2008 and 8% in 2009 GDP. The bourse was
introduced as the first electronic market in the 1990s that comprised of trading, settlement,
clearing, and depository (Mourad, 2018). Tadawul market is rose up to 3.8% in March 2019 that
equals to SAR 2.087 trillion (Argaam, 2019).

Saudi Arabia is the major country in the Middle East and North Africa (MENA) region due
to market capital, but this country has unbolted its stock market to full international participation.
In the stock market exchange, 15 sectors are listed such as banks and financial services accounts
44% in the net income of Saudi Arabia, petrochemical industries accounts 24%, cement accounts
5%, retail accounts 3%, energy, and utilities accounts 2%, agriculture and food industries account
3%, telecommunication and information technology accounts 8%, insurance accounts 3%, multi-
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investment accounts 0%, industrial investment accounts 1%, building and construction accounts
1%, real estate development accounts 2%, transport accounts 3%, media and publishing accounts
0%, and hotel and tourism that contribute 1% respectively in the net income of Saudi Arabia.
Overall, five sectors have shown profits decline while five sectors increased their profit. Out of
five sectors, the insurance companies accounted for the high growth rate of 144% that means SAR
1.4 billion added as per previous years that increased their contribution up to 3% of the market
profits (Opening Saudi Stock Market to Foreign Direct Investment, 2015).

1.3 Broad Problem Area

The aggregate bottom line of listed corporations in the Saudi Stock Exchange was dipped
up to 6.7% in the quarter 4 of 2016 that resulted from the decline in 5.3% in the final year of 2016
compared to last year. The aggregate profit of the company changed by 16.11 billion SAR for
quarter 4 in 2016 compared to 17.26 billion SAR in quarter 4 of 2015. The decline in profit was
due to the low earnings in the financial and banks service sector that were down up to 5.3% YoY,
which showed 44% profit of market (Saudi Stock Exchange, 2017). Four banks recorded profit in
2016, but the profit of other eight banks become lower than the previous years due to the increase
in the credit losses provisions as well as due to the slowdown of domestic economy and inadequate
liquidity conditions.

It’s obvious how much important for the management of the commercial banks,
stakeholders and other interest groups such as the central bank and the government to grasp and
realize the bank specific factors and their impact on the profitability and financial performance of
the bank. A wide range of research studies were managed to evaluate the internal and external
aspects that defines the commercial bank profitability and the financial performance especially the
stock return. All of these studies detected several internal specific factors which are usually know
as bank specific factors, external and industry specific factors. Clearly known that the bank specific
factors are the private ones or the factors particular to a given financial institution. Consequently,
the internal factors that determine profitability in one bank are different from other banking
institution in general and same rule applies in Saudi Arabia. A review in literature indicates that
several research studies done on local and international arena concentrated on specific factors.

This study neglected the banking industry specific factors in Saudi Arabia and how banks
performance affects each other in the market of KSA. Moreover, some other factors were omitted
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that may have a significant effect on the bank performance like the dividend policy and the bank
ownership. These factors are among the research gap, which may influence the bank profitability
and should be considered for further investigations and researches in future.

The performance of commercial banks can be affected by internal and external factors.
These factors can be classified into bank specific (internal) and macroeconomic variables
(external). The internal factors are individual bank characteristics, which affect the bank's
performance. These factors are influenced by the internal decisions of management and board. The
external factors are sector wide or countrywide factors, which are beyond the control of the
company and affect the profitability of banks. The internal factors include bank size, capital,
management efficiency, risk management capacity. The same scholars contend that the major
external factors that influence bank performance are macroeconomic variables such as interest
rate, inflation, GDP, oil price, economic growth, and other factors like ownership.

CAMEL framework often used by scholars to proxy the bank specific factors. CAMEL
stands for Capital Adequacy, Asset Quality, Management Efficiency, Earnings Ability and
Liquidity. The study is to find out the relative importance of the factors that influence performance
of commercial Banks in Saudi Arabia. Therefore, the problem under investigation is to find out
the factors that affecting stock return and performance of commercial banks in Saudi Arabia.

1.4 Problem Statement

Limited researchers have investigated the determinants of financial performance of banks
in Kingdom of Saudi Arabia and this empirical study aims to examine the impact of internal and
external factors of CAMEL framework influencing stock return of profitability of banks in
Kingdom of Saudi Arabia.

1.5 Significance of the Study

The main purpose of this study is to fill in the knowledge gap on some of the factors
affecting financial performance of commercial banks listed on the Saudi Stock Exchange, which
is called Tadawul. (Saif-Alyousf, Saha, & Md-Rus, 2017)The main purpose of this thesis study is
to determine the factors affecting the financial performance, profitability, and stock returns of
commercial banks in Saudi Arabia. The results and feedback of this study will be beneficial to the
central bank of Saudi Arabia SAMA, which is the main player and regulator in this sector by
providing the guidelines to adverse regulatory systems and supervisory program to tolerate the
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operations of all commercial banks and other financial institutions in addition to the capital market
authority CMA.(Solaiman, Kadar, Wanke, & Azad, 2017)

Moreover, this thesis will benefit the management and the board of directors of any
commercial bank in Saudi Arabia to understand better the effects of the bank specific factors and
macroeconomic variables on their financial performance, profitability, and stock return. It also can
be insightful for the managers and directors to take the needed steps that guides the bank to be in
a better position and continuously improving the profitability value. As a further step, it can be
considered as a framework that helps in the assessment process of the bank’s financial
performance, profitability, and stock return with respect to the determinants and factors mentioned.
It can also be used as a reference for information on individual determinants of financial
performance, profitability, and stock return especially the CAMEL parameters, GDP, inflation
rate, interest rate. The preparation of these determinants will provide detailed information and data
on each of the mentioned factors and therefore participating to the body of the knowledge.

1.6 Study Objectives

The results of this study will be beneficial to various stakeholders, regulators, commercial
banks, investors, scholars and stakeholders across Saudi Arabia in specific and the world in general
to understand the factors driving stock return and profitability in commercial banks.

This study is guided by the following research objectives.

1. Establish the effect of all possible internal and external factors affecting the bank
profitability.

The specific research objectives can be briefed as follows:

1. Determine the impact of the bank management efficiency and profitability.

2. Determine the impact of the bank earnings ability and profitability.
3. Determine the impact of the macroeconomic variables (i.e. GDP, inflation rate, and
interest rate and oil prices changes) on the profitability.

1.7 Research Questions

The study seeks to answer the following research questions:
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1. What is the impact of the bank management efficiency on the profitability -of banks
listed in Tadawul?
2. What is the impact of the bank earning ability on the profitability of banks listed in
Tadawul?
3. What is the impact of macroeconomic variables (i.e GDP, inflation rate, and interest rate
and oil prices changes) on the profitability of banks listed in Tadawul?

1.8 Conceptual Framework

Internal Factors

IV1: Banks management

Efficiency
IV2: Banks Earning
Ability
Financial
Performance
DV1: Profitability
External Factors

IV3: GDP growth Rate

IV4: Inflation Rate
IV5: Interest Rate
IV6: Oil Prices

1.9 Study Hypothesis

Based on the objectives mentioned above, we conclude the following research hypothesis:

1. H1: There is a significant impact of internal factors on profitability of the commercial

bank.
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 H1a: There is a significant impact of bank management efficiency on profitability

of the commercial bank.
 H1b: There is a significant impact of bank earnings ability and profitability of the
commercial bank.
2. H2: There is a significant impact of external factors (macroeconomic variables) on
profitability of the commercial bank.
 H2a: There is a significant impact of GDP on profitability of the commercial
bank.
 H2b: There is a significant impact of inflation rate on profitability of the
commercial bank.
 H2c: There is a significant impact of interest rate on the profitability of the
commercial bank.
 H2d: There is a significant impact of oil price on profitability of the commercial
bank.

1.10 Scope and Limitations of the Study

This thesis study covers out n=12 commercial banks in the banking sector of Saudi Arabia
regulated and licensed by SAMA, the central bank of KSA. The observations were taken out from
the secondary data of the annual financial statements of the commercial banks in Saudi Arabia that
were active and in action between 2005 and 2016, where this period of twelve years is considered
as a sufficient time interval to monitor the changes in the commercial banks over time.

The work done throughout this study could be significant since many rules and regulations
for either banking or any financial institution were put into action while there exist many factors,
internal or external, that can affect the financial performance in general and the profitability and
stock return in specific of the financial institution. The internal factors include bank size, capital,
management efficiency, risk management capacity. The major external factors that influence bank
performance are macroeconomic variables such as interest rate, inflation, oil price, GDP, economic
growth.

This limitation of this research is that some of the factors were not considered under study
and these factors can be influential for the financial performance of a banking institution. The
factors that are not included are exchange rates, dividend policy and political state. The exchange
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rate can be also considered as an important factor since the Saudi Arabia currency, which is Riyal,
is directly connected and reflected against the US dollars. Therefore, for further studies and
investigations, these two factors are of a much importance to be investigated. The current research
only considers the factors mentioned before and it was conducted based on a timeframe of twelve
years between 2005 and 2016. In the current study, there is a need for further analyses that relates to
external factors of financial performance of banks in the KSA region. This research uses only data related
to 2005 to 2016 and uses 8 banks and their financial statements. Therefore, a further research would be
beneficial that will help to extend the existing knowledge provided by the present study. Moreover, the
study scope is also limited because there is no primary data collected and the research depends on only
secondary data from the banks’ financial reports and websites. The research only uses banks in the KSA
and no foreign banks are included for the research purpose.
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CHAPTER 2

LITERATURE REVIEW

2.1 Saudi Arab Banking Industry

Saudi Banking system is stable because of the ease of funding pressures. In the Saudi Stock
Exchange, 24 banks are listed, in which 12 are local banks, and one is the foreign banks (Branches
of foreign banks). The listed local banks in Saudi Stock Exchange are (a) ALAWWAL Bank
(Saudi Equity Fund), (b) ARNB Bank (Arab National Bank), (c) BJAZ ( Bank Al-Jazira), (d)
BSFR (Banque Saudi Fransi), (e) RIBL Bank (Riyad Bank), (f) RJHI Bank (Al Rajhi Bank), (g)
SABB Bank (Saudi British Bank), (h) SAMBA Bank, (i) SIBC Bank (Saudi Investment Bank), (j)
Alinma, (k) NCB, and (l) Albilad(Saudi Stock Exchange, 2017).In the Saudi Stock Exchange,
banks are categorized into two groups, including commercial banks and Islamic banks. Out of 12
banks, four banks are Islamic that are Al Jazeera Bank, Al-Rajhi Bank, Alinma Bank, and Al-Bilad
Bank(Intel, 2019). The detailed information of the banks is given here.

(a) ALAWWAL Bank (Saudi Equity Fund)

Saudi Equity Fund is also known as ALAWWAL Bank that was developed in 1926. It is
known as the old bank in Saudi Arabia. This bank delivers investment and banking -amenities in
the Kingdom. This bank also functions through personal banking, commercial banking, investment
services, investment banking, ALCO segments, and Central Treasury. It is located in Riyadh that
employs approximately 2600 individuals within the 65 branches of the world. This bank was
renamed in 2016 from Saudi Hollandi Bank to the ALAWWAL bank. As per the statistics of 2016,
the bank assets were approximately US$8 billion, and the net profit wasextended up to 283 million
US dollar (AlawalBank, 2017).

(b) ARNB Bank (Arab National Bank)

Arab National Bank is mostly known as ARBN bank that was developed in 1979. Thisbank
is located in Riyadh. It offers investment and commercial banking services. It also provides
particular services in the heavy equipment home finance and leasing. It operates local offices in
Khobar and Jeddah. It also has one branch in London. The company works around a million
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customers in the 95 branches worldwide. The company has 4400 employees in retail banking,
treasury banking, corporate banking, brokerage and investment services, and others. The bank
showed total assets of 45.3 billion US dollar as well as net profit of 763 million US dollar (ARNB,
2017).

(c) BJAZ (Bank Al-Jazira)

Bank Al-Jazira is also known as BJAZ, which is the public company, registered in the
Saudi Stock Exchange. The bank was founded in 1976. It operates in the banking sector and
focuses on diversified banks. This bank is headquartered in Jeddah, Saudi Arabia (Aljazira, 2019).

(d) BSFR (Banque Saudi Fransi)

Banque Saudi Fransi is also known as BSFR that provides international and local banking
services to the customers. The bank has 3000 employees within its 83 branches. The bank is located
in Riyadh, but it has three local offices located in Al-Riyadh, Jeddah, and Al-Khob. As per the
statistics of 2016, the total assets of bank amounted to 54.2 billion US dollar, and the net profit of
the bank will reach up to 936 million US dollar(BSFR, 2017).

(e) RIBL Bank (Riyadh Bank)

Riyadh Bank is also known as RIBL that was developed in 1957. The bank was
headquartered in Riyadh. The bank provides corporate and retail products and services that are
acquiescent with the Islamic values of Sharia law. The bank is known as the foremost financier
and director of syndicated loans for petrochemicals, oils, and infrastructure products among the
Saudi Arabian banks. The bank showed the total assets of 58 billion US dollar and the net profit
of 91 million US dollar in 2016(RIBL, 2017).

(f) RJHI Bank (Al Rajhi Bank)

Al Rajhi Bank is also identified as RJHI that gives personal, Islamic, home financing, and
auto banking services. It provides banking investment elucidations in Saudi Arabia. The bank is
located in Riyadh. The bank has 9000 employees in its 500 branches. This bank is located in
Jorden, Kuwait, and Malaysia. The total assets of the bank were 90.6 billion US dollar and had a
net profit of 2.2 billion US dollar as per the statistics of 2016(RJHI, 2017).
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(g) SABB Bank (Saudi British Bank)

Saudi British Bank is also named as SABB bank that is located in Riyadh. The company is
the Joint Stock, and it is linked with HSBC Group. The bank provides investment banking,
commercial banking, Islamic banking, and private banking services to the customers. The bank
operates the branch that is located in London. As per the statistics of 2016, the total assets of banks
were US$ 49.6 billion, and the bank had a net profit of US$1038 million(SABB, 2017).

(h) SAMBA Bank

Samba bank was developed in the 1980s, and it provides financial services to the people
of Saudi Arabia. The bank has 72 branches in Saudi Arabia, 28 branches in Pakistan, one branch
in Qatar, London, and Dubai. This bank is located in Europe, GCC, and South Asia countries such
as Qatar, Dubai, and Pakistan. As per the 2016 statistics, the total assets of the bank are US$ 61.7
billion, and the net profit of the company extended up to 1.3 billion US dollar(SAMBA, 2017).

(i) SIBC Bank (Saudi Investment Bank)

Saudi Investment Bank (SIBC bank) was developed in 1976. This bank is headquartered
in Riyadh, and it delivers banking and investment services. The bank provides retail, wholesale,
and commercial banking products. The bank arranges to finance for the private industrial sector
for exporters and importers. The company has 1600 employees throughout the world. The
shareholders of this bank are Mizuho Corporate Bank, Morgan Chase, private institutions, and the
Saudi public. As per the statistics of 2016, the bank showed the total assets of 25 billion US dollar
and the net profit of 280 million US dollar(SIBC, 2017).

(j) Alinma

Alinma Bank was developed in 2006. This bank gives investment and banking services in its 76
branches worldwide. The bank operates in numerous segments such as corporate banking, retail
banking, investment, treasury, and brokerage. As per the statistics of 2016, the total assets of the
bank were estimated up to 28 billion US dollar, and the net profit of the bank was US$400
million(Alinma, 2017).

(k) NCB (National Commercial Bank)

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National Commercial Bank is also named as Alahli bank. It is the principal bank in Saudi
Arabia and the pioneer of Islamic banking. This bank is located in Jeddah. It has 9035 employees
and more than 5 million customers in its 374 branches. As per the statistics of 2016, the bank had
total assets of 117 billion US dollar, and it has a net profit of 2.5 billion US dollar(NCB, 2017).

(l) Albilad

Bank Albilad is the stock company of Saudi Arabia that was developed in 2004. The motive
of this bank is to deliver Sharia-based banking services to the customers. The company has the
corporate capital of 6,000 million Saudi Riyals(Albilad , 2019).

2.2 Financial Performance in terms of ROE

The origin of the word performance goes back to the word “parfourmen” that means to
render. It is the act to perform, execute, accomplish, and fulfill(Haidary & Abbey, 2018). In the
broader domain, financial performance is linked with the fulfilment of tasks on the preset standards
of completeness, cost, speed, and accuracy. The two most common indicators of financial
performance are stock return and profitability.

Return on investment ROE is an appropriate measure to measure the financial performance

of a company such as commercial bank. ROE helps researchers to identify whether a company is
operation with profitability or is unprofitable. ROE is a valuable metric that helps to establish the
relationship between company’s returns and profits. ROE is calculated using the following
formula:

Return on Equity ROE= Net Income / Shareholder’s equity

Even though ROE is not a perfect metric to measure the firm’s profitability and financial
success,an increase in ROE identifies company’s overall success and improvement in its
operations. The managers can interpret the five year’s results to determine the competitive
advantage of the firm, which is why, ROE is a useful tool to identify the effectiveness of firm’s
leadership. In addition to Return on Assets ROA, ROE also effectively measures the company’s
earnings generated from its key investors. It provides a clear understanding of management’s
 16

effectiveness and indicates that shareholders are getting a good return of their investment from the
organization (Phillips, 2011).

In measuring the financial and human development of companies, ROE has earned its place
among the valuable metrics. Measuring ROE correctly is vital, which is why much debate
surrounds the topic of measuring ROE. Some interpreters experience accountability concerns and
find issues in measuring ROE; however, taking a rational approach to the issue and using the best
strategies can help to mitigate issues in the measurement of ROE. An effective ROE framework
or model can be applied to financial organizations in the real world to guage the effectiveness of
their leadership strategies. Therefore, return on equity ROE is a vital determinant of firm’s overall
profitability and financial performance (Batchimeg, 2017).

In the rising trend of globalization, the financial institutions are feeling greater pressure to
improve their profitability and competitiveness; efficiency and effectiveness of a firm helps to
determine the competitiveness. Not all the sectors of industry have the same indicators for
measuring their performance; they differ from industry to industry in terms of characters and
operations. Banks and financial institutions are compared with each other that allows researchers
to guage their performance and financial stability. Therefore, a company’s performance is
measured by what a company achieves over a period of time; the related information also assists
managers to make wise decisions in the future (Kipesha, 2014).

Profits of a financial institution show whether managers are performing effectively in the
organization or not; it helps to identify whether managers are making wise investment and
financial decisions. Therefore, Return on Equity and Return on Investment (ROE and ROI) are the
most important tools that sow a solid connection between the financial performance and
profitability of a firm. In addition to ROE, capital structure of a firm also helps to determine its
performance; a greater debt ration can have a direct negative impact on the financial performance
of a company. Therefore,, ROE helps managers to perform effective liquidity management that
helps companies to survive and thrive in the long run (Kajola, Sanyaolu, Alao, & Ojunrongbe,
2019) .

Mirza (2013) explains that Return on Equity ROE is an important measure for any
organization because a good value of ROE represents that the organization is doing well . In the
 17

balance sheet, ROE helps to determine how much profit a company has earned that helps managers
to compare the company’s performance with its rivals (Mirza, 2013). The author also argues that
companies who need to invest heavily into infrastructure often possess lower values of ROE as
compared to companies with higher value of ROE; which is why ROE is such a vital measure to
measure the performance of organizations in the same sector or industry. Therefore, a financial
institution is more capable to generate cash if it has a higher value of ROE and raises more money
for future development and growth (Veronika, 2014).

Burca (2014) suggests that company managers are often familiar with the term Return on
Equity ROE that is a tool to measure the core financial strenht of a company. ROE expresses the
firm’s profitability’s results in terms of a percentage that provides a better understanding of its
finances to managers and competittors (Burca, 2014). The study also states that ROE provides a
useful comparision of how much profit a firm generates in the tough business environment using
all the dollar resruoces it possesses. Return on Equity ROE significantly matters to guage the
efficiency and corporate strength of an organization. It also shows a clear picture of how managers
are able to manage the shareholder’s money; therefore, ROE values are always a positive sign
when they are higher as compared to negative values(Veronika, 2014).

Dasuki (2016) discusses the effect of capital structure on the financial performance of an
organization such as bank or an insurance company. The author states that investors are able to
break down their income using values of Return on Equity ROE to build profitability for their
business. For example, if a business spends 500 dollars to generate monthly sales, whereas, it earns
one million dollars income per month. Therefore, the business model looks significantly healthy
with a higher Return on Equity ROE figure (Dasuki, 2016).

Kipesha (2014) explains the use of Return on Equity ROE to help organizations maximize
their profitability and efficiency. The author shows three most effective methods of using Return
on Equity in organizations including dividend payments, growth strategy, and DuPont Formula.
When a company is able to pay high dividends to its shareholders, it portrays a healthy financial
performance of an organization. A well-earning organization can pay high dividends to its
investors and also has sufficient funds or capital to meet its goals and requirements. Similarly,
growth strategies often indicate how fast a company can achieve its growth objectives using ROE
 18

values. Many companies use retention ratio effectively to roughly calculate or judge the future
development of an organization. Retention ration represents that investment amount that a
company retains after paying its dividends. Finally, the author explains the strategy of DuPont
Company that used ROE in a rather complex way. The DuPont calculates ROE by multiplying
sales with net income and total shareholder’s equity. This approach is also effective to help
investors to gauge the company’s financial performance effectively (Kipesha, 2014).

2.2.1 Firms Profitability

Kajola, Sanyaolu, Alao, and Ojunrongbe (2019) defined profitability as “It depicts the
ability of a firm to generate revenue in excess of attributable costs incurred in generating revenue
from all its activities (p. 2).”Mathuva (2015) defined that “profitability is the ability of the
company to use its capitals for generating revenues more than the exerted expenses.” In other
words, “profitability is the capability of the firm to generate profit from its operations.”Ball,
Gerakos, Linnainmaa, and Nikolaev (2015) stated that “profitability is linked with profit, but profit
is the absolute amount, while profitability is the relative one.” Profitability is used to measure the
scope of the frim profit by linking it with the size of the businesses. Profitability is the efficiency
measurement and ultimately results in failure or success. Borio, Gambacorta, and Hofmann (2017)
defined profitability as “it is the business ability to earn the profit.”A profit is the revenues
generated by the business after paying all the expenses. Dvorkin and his fellows (2016) stated that
“profitability is the situation in which the entity generates a profit.” Profitability manifests in the
business when the aggregate amount of revenue is more than the aggregate amount of expenses in
a specific period. Profitability can be attained through the sales of assets that result in immediate
gains. It is one of the business measure used for deriving the business valuation. Profitability is
one of the four building blocks to analyze the monetary statement of the firm and performance of
the firm as a whole. The other three building blocks are solvency, efficacy, and market prospects.
The creditors, investors, and managers use this concept for analyzing the doing of the company.
The key components of profitability are returns and expenditures. Revenues are the incomes of the
businesses that are received from customers through selling products or giving services.
Profitability measures the association between the expenses and revenues to measure the
performance and future growth of the company (Kajola et al., 2019).
 19

Numerous measures are used for measuring the profitability of the firm such as Gross profit
margin, EBITDA Margin, Operating Profit margin, Net profit margin, and cash flow margin, ROA,
ROE, and Return on Invested Capital.Gross Profit Margin is the first measure used to associatethe
gross profit of the firm with the sales revenues. It reflects how business is earning as well as explore
the desirable costs for producing its services and goods. A high-profit margin ratio shows greater
efficiency of the essential operations. The low-profit margin shows the high costs of the sold
goods, and it is linked with harsh purchasing policies, stiff market competition, low selling prices,
and wrong promotion policies. EBITDA Margin is the second way to measure firm profitability.
It stands for Earning Before Interest, Taxes, Depreciation, and Amortization. It measures the firm
profitability before accounting the non-operating items such as taxes, interest, and non-cash items
such as amortization and depreciation. It is the best measure for profitability because it can be
easily compared with other firms. It is anextensively used measure in the assessment methods.
Operating profit margin is the third measure that focuses on earning as a sales percentage before
income taxes and interest expenses are deducted. The firm has high operating profit margins are
more fortified for paying fixed costs and obligation interests. They have a good chance of surviving
the financial slowdown as well as proficient of proposing lower prices than the entrants that have
a lower profit margin. Net Profit Margin is the fourth measure that divides net income of the firm
with total revenues. It gives a complete picture of the profitability of the firm, including taxes and
interests. Cash Flow margin is the sixth measure for profitability that experiences the association
between cash flows from operating endeavors and sales generated through the corporate. It
measures the firm ability to change cash into sales. The seventh measure, ROA, shows the
percentage of net earnings relevant to the total assets of the firm. The eighth measure, ROE, is
used to show the percentage of net income related to the stockholders' equity. Lastly, Return on
Invested Capital is the profitability measured that is generated by all capital providers, such as
shareholders and bondholders (CFI, 2019). Hitt and Brynjolfsson (1996) used ROA, ROE, and
total return to measure the profitability of the firm. Rai and his fellows (1997) used ROA and ROE
to measure the profitability of the firm. Later on, in 2007, Aral and Weill used Net Margin and
ROA to measure the firm profitability. Mithas, Tafti, Bardhan, Goh (2012) used net income per
employee to measure the firm profitability. Anandasayanan and Thirunavukkarasu (2016) used
dividend yields to measure the profitability of firms of Sri Lanka.
 20

Lin (2018) defined that “return is also known as the financial return or the money lost or
made on the investment within a specific time period.” Return is expressed in the form of
percentage derived from profit to investment ratio. Return can be shown in the form of net results
after taxes, fees, and inflation, while gross return does not include anything except price change.
Choi, Jacewitz, and Park (2016) defined that “stock market returns are the returns that depositors
produce out of the stock market.” The stock return can be in the form of dividends or profit
provided by the firm to the shareholders after a specific time period. Stock market returns are made
through the dividends that are announced by the firm. The most common way to generate a stock
return is through secondary market trading. Chava, Gallmeyer, and Park (2015) defined stock
returns as “it shows the mixture of dividends and stock price maximization or capital gains. The
firm ear high return on capital but the shareholders undergo if the market price of the stock
declines.” Narayan and Liu (2018) stated that stockholders get benefits to hold stock over a
specific period if the stock would be sold at a high price or if dividents are directly paid to owners.
“The total stock return is the sum of share price changed and total dividends and then divided by
the initial price of the stock” (Narayan & Liu, 2018). The total return on stock combines the
dividend payments and capital appreciation, and compare both of them with the stock price at the
start of the period. It is the return rate or yield that investors got benefits by directly holding the
stock. Rostami, Rostami, and Kohansal (2016) defined stock return as “it is the vital factor to
select the paramount investment opportunity for investors.” Zhong and Enke (2017) stated that
stock return is either positive or negative if money is exerted in stock, the more money is expected
on the stock that is known as positive stock return, while when less money is get back compared
to exerted money, then it is known as a negative return.

The most commonly used measures for stock return are Return on Investment (ROI),
Return on Equity (ROE), and Return on Assets (ROA). ROI is the return that is expressed in
percentages. It is the return per dollar capitalized. It is calculated by dividing the dollar return by
the dollar initial investments. This ratio is multiplied with 100 to get an accurate percentage of
stock return. ROE is the profitability ratio that is calculated by dividing the net income with the
average shareholder's equity that shows that way net income is generated per dollar of the stock
investment (Hatem, 2017). ROA is another profitability ratio used to measure the stock return in
the firm. It is calculated by dividing the net income by average total assets that show how to profit
is generated for each dollar investment on the assets. It is used to determine the financial leverage
 21

as well as it is earned from asset use for covering the capital cost. The net income divided by
average total assets become equal to ROA (Hayes, 2019). Hatem (2019) used ROA and ROE to
measure the stock return of the firm.

ROE is an effective meauring tool of performance for the business owners but its not a risk
adjusted return measure therefore, ROE should be adjusted accordingly when comparison of
risk based investments are required (Miller, Boehlje, & Dobbins, 2001). Measuring financial
performance with the help of financial ratios is phenomena that has been used in many previous
studies aswell. It is very crucial for all investors that financial performance is measured with
respect to profitability with the right measure to make sound business decissions. Return on Equity
(ROE) is used to measure that how well the firm is able to produce earning efficiently using
resources of the firm. Basically, ROE measures the profit againts the investments made by the
shareholders in the company. The drivers that lead to higher ROE are sales turnover, high proft
margins and higher debt proportions (Gopi, 2018). Batchimeg, (2017) conducted a study on
Mangloian companies in order to identify the financial ratios that are adequate for measuring
financial performance of firms. 100 joint stock companies were selected as the sample for the
research and the financial statements from 2012 to 2015 of these companies were analyzed. The
indiacator that were used for measuring performance included return on assets (ROA), return on
equity (ROA) and return on sales (ROS). The finding of the study showed that ROA has a higher
impact on financial performance of firms than ROE and and ROS. Dasuki, (2016) conducted a
study on 180 manfacturing firms listed on the Borsa Stock Exchange of Turkey from the periof of
2004 to 2013. He used ROA and ROE as measures of financial performance and the findings
showed that long term debt and total debt have insignificant impact on financial performance
measured by ROE wheras, the findings showed that long term debt and total debt had negtive
impact on financial performance measured by ROA. Businesses that have higher returns on equity
are able to generate cash more quickly when in need.The biggest advantage of using ROE as a
measure for financial performance is that it can give the comparison of performances between two
companies or two sectors. It has been identified that ROE and total debt to assets have significant
relations with each other (Xu, 2015). Vintilă & Nenu, (2015) conducted an analysis of
determinants of corporate financial performance by taking evidence from the companies listed in
the Bucharest stock exchange showing that ROE is a sginficant measure of financial performance
as there is a positive relation between company size and firm performance measured by ROE.
 22

In the study conducted by Zhang, Yuan, & Zhi, (2017) analyzed the use of ROE as a
performance measure in performance-vested stock option contracts in China showed a) first of all
ROE is a widely used measure for measuring financial performance b) It is different from other
financial measures as it can be affected shares that remain outstanding c) Managers are given
incentives and the power to influence ROE performance through financing decisions to avoid ROE
dilution d) Lastly, bank managers avoid ROE dilution when manager’s performance-vested stock
option plans are tied to ROE performance and when companies have a higher access to bank loans.
Firms that have a higher ROE can be translated as more returns on investments for the shareholders
or investors. There are factors that can affect ROE which include tax burden, interest burden,
operating margin, asset turnover and financial leverage. In 2011, study was conducted by Saleem
and Rehman in order to examine the association between liquidity and profitability among the oil
and gas companies in Pakistan. Their findings showed that liquidity showed a significant impact
on ROA whereas insignificant impact on ROE. Furthermore, it was found current ratio; quick ratio
and liquidity ratio significantly affect the ROE. In another survey on Jordanian insurance
companies from the year 2002 to 2007, it was found that ROA, ROI and ROE have a strong
association with respect to share prices and market returns, whereas, the association of ROA &
ROI shows low impact on share price. Companies with high profit equity ratios tend to have lower
ROE within the next few years (Kharatyan, Nunes, & Lopes, 2016).

Performance measurement is one of the core components of strategic management.

Measuring of performance is crucial for every firm to identify the performance gaps from certain
duration and time. Thus, a good measuring standard or tool is necessary for managers with the
help of which they can use key information and statistics in order to monitor performance and
make adequate changes to report progress. Performance and corporate governance measures are
based upon different accounting indicators and one of the widely used accounting measure for
performance is return on equity (Al-Matari, Al-Swidi, & Fadzil, 2014). Past studies of (Obiyo &
Lenee, 2011; Rouf, 2011; Pandya, 2011; Prabowo & Simpson, 2011) have used ROE as a measure
of performance.
 23

2.3 Theoretical Framework

The theories used to explain the study variables are discussed here in detail in the
theoretical framework that uses appropriate theories to explain the research topic.

2.3.1 Modern Portfolio Theory

There is not any concept of perfect investment, but to create a strategy that provides high
returns and low risks is the priority of the investors in the modern era. This strategy actually existed
in 1952 by an economist named Harry Markowitz. The modern portfolio theory reflects how
investors create portfolios for optimizing the expected return depends on the market risk level,
which is the inherent part of the reward. Based on this theory, it is probable to construct an effectual
frontier for the ideal portfolios that compromise the possible predictable outcomes in the given
risk level (Bami, 2014). This theory argues that risk and return characteristics of the investment
should be observed alone, but it should evaluate how the investment affects the portfolio of return
and risks. The investors can develop a portfolio of multifaceted assets that can maximize the
returns for the given risk level. This theory assumes the investors in the risk-averse and rational
state as such numerous investment choices are listed in the portfolio. The investors’ opportunities
have reward and risk that reflects that the efficient frontier need to be constructed where investment
combinations will be provided to the return and risk and the efficient frontier will be the best risk-
reward combination. According to this theory, there are two major components of risk within the
stock returns, i.e., systematic risk and unsystematic risks. Systematic risks are linked with the
market risk that cannot be minimized through diversification. It is the possibility that the whole
economy and market show losses that in turn, affect the investment. It is crucial to note that modern
portfolio theory can moderate this type of risk, and it is inherent for the whole market or its
segment. On the other hand, unsystematic risks are called the specific risks that are specific to the
stocks, which means that it can be diversified if the stock is increased in the portfolio (Mujuka,
2018). This theory relates with the CAMEL framework as it explores specifically the stock returns
that is used as a dependent variable in this study. Due to the effectiveness of this theory, it is used
in the literature for investigating the banks’ profitability that clearly manifests its link with the
micro and macroeconomic factors of profitability. Bami (2014) used this theory to gauge the banks'
profitability in the context of the Albanian banking sector. Mujuka (2018) has used modern
 24

portfolio theory to explore the factors influencing the financial performance of Commerical banks
in Kenya.

2.3.2 Resource-based Theory

The resource-based theory is used to indicate the resources that increase the profitability
of the business. This is the novel approach to attain a modest benefit, and this approach has
emerged at the end of the twentieth century. The resource-based theory states that the possessions
of resources are valuable but complicated to imitate, and it cannot be substituted. This theory
suggests that firms should look inside for finding sources for competitive advantage through using
their resources. The competitive advantage is benefit the organizations have over their competitors,
and this advantage allows them to generate sales or retain more customers than the competitions.
The competitive advantage of the firm evolves from the resources that organizations already
possess. This theoretical model reflects that the major role of resources is to sustain companies in
term of achieving effective firm performance as well as a competitive advantage. This theory
prescribes that the organizational position is based on its capabilities and resources (Hitt, Xu, &
Carnes, 2016).

The key term within this theory involves (i) tangible resources, (ii) intangible resources,
and (iii) capabilities. The resource-based theory states that the tangible resources are the ones that
can be touched, seen, and quantified such as property, equipment, factory, and cash of the
company. The firm must have this type of resources for effective management. Effective
management is linked with good financial performance. Intangible resources are everything other
than the physical things or the things that have a physical presence. The intangible assets within
the firm include trademarks, brand reputation, and intellectual property rights. The intangible
resources mainly stay within the firm and are the major source of sustainable competitive
advantage. Capabilities are another important key concept. Just like the resources, that the
organization possesses but capabilities are all those activities that an organization performs.
Capabilities mostly arise with the passage of time within the firm, but the firm take actions on is
strategic resources. The major two assumptions of resource-based theory should be heterogeneous
and immobile. The first assumption is that capabilities, skills, and resources within the
organization vary from one firm to another. If the firm has a mix of resources, then they use various
strategies for out-competing each other. The second assumption is that the resources are not mobile
 25

and cannot move from one firm to another. Due to immobile nature, firms cannot change their
rivals' resources and implement the same practices. Intangible resources such as processes,
intellectual property, and knowledge are mostly immobile (Makadok, 2010). This theory relates
with the CAMEL model as it explores the capabilities, resources, and skills practiced within the
organization. The factors such as management efficiency and earning abilities are the internal
capabilities of the firm that is why this theory has practical implication in the literature.

2.3.3 Arbitrage Pricing Theory

Arbitrage pricing theory is the theory of asset pricing that keeps return on assets, and it is
forecasted within the linear relationships of expected returns of assets as well as macroeconomic
factors that influence the assets' risk. This theory was developed in 1976 by Stephen Ross. This
theory provides a pricing model to the investors and analysts for securities that depend on the
association between the economic assets that are expected a return on its risks. This theory gives
the just market price of a sanctuary that is primarily erroneously priced. This theory reflects that
market action upshots in assets, either underestimated or overestimated for a specific time. Market
action sorts out the situations and moves the price back to the just market value. The shortly
mispriced sanctuaries show the short-term prospect to provide risk-free profit to the customers.
This theory is the most complex and flexible alternative to the Capital Asset Pricing Model. This
theory delivers opportunities to investors and analysts for customizing their research. It is
complicated to relate, as it needs time for determining all numerous risk factors that touch the price
of assets. This theory operates within the pricing model that process in numerous risk and
uncertainty sources. This theory is dissimilar the Capital Asset Pricing Model because of that
focus on only a single factor of the risk level of the whole market. This theory focuses on numerous
macroeconomic factors to determine the return and risk of a particular asset. The returns on assets
follow the linear array. The investors can influence deviation from the linear pattern by using
arbitrage strategy. It is the training of purchase and sale of the asset, getting the advantage of slight
pricing discrepancies to lock it in the risk-free profit for the trade. The theory provides higher
flexibility to the investors and analysts (Sekreter, 2017). This theory is majorly linked with the
macroeconomic factors such as the inflation rate, interest rate, GDP, and oil prices so this theory
provides an effective theoretical background to the literature.
 26

2.3.4 Management Theory of Frederick Taylor

Taylor was the American inventor who applied his scientific knowledge to the
management. The management theory can be applied in all the modern firms in various businesses.
His work can be seen in production planning, process design, control, cost accounting, and quality
control, and ergonomic. The majors of the theory revolve around the management within the firm.
Management efficiency is the major factor that reflects the firm productivity that is clearly
highlighted in this theory. This theory focuses on improving every individuals' efficiency within
the firm. The major focus of the firm is to increase production by using intensive technology. In
the firm, all human beings are taken as the adjuncts to machines while performing routine tasks.
The major principles of this scientific theory are effective planning for the projects that are
supposed to be accomplished within the organization. Effective supervision is mandatory for
management related endeavors. The fatigue, time, and motion studies reflected that a fair amount
of work should be taken from the participants. It is necessary to better the work condition and
standardize tools, cost of production, and work period(Caramela, 2019). This theory is linked with
the CAMELS framework especially with the management efficacy that should be implemented in
the production planning,, quality control, and process design. .

2.4 CAMELS Framework

CAMELS is the framework that was developed by the supervisory authorities of the United
States to rate financial institutions, especially banks. This rating system is applied to every bank
in the U.S as well as outside the US in financial institutions. National Credit Union adapted this
rating system in 1987. Later on, in 1988, the Basel Committee on Banking Supervision of the Bank
of International Settlements (BIS) had projected that CAMELS framework could be used to asses
all financial institutions. CAMELS system was developed with the purpose to assist supervisory
authorities to recognize banks that need supervisory concern. The rating is assigned to the banks
and monetary institutions based on their financial statements. This framework is used for
measuring financial stability and risks of a bank. It measures the inclusive conditions of banks in
the executive, monetary, and operative domains. The initials of six components are taken from the
word CAMELS that stands for Capital Adequacy, Asset Quality, Management, Earnings,
Liquidity, and Sensitivity (Aspal & Dhawan, 2016).
 27

2.4.1 Capital Adequacy

It is the first component of CAMELS that is crucial for the banks to uphold the confidence
of investors. It prevents the bank to become bankrupt. It shows the overall economic conditions of
banks as well as it is the management ability of banks to fulfill the additional capital needs(Priya,
2019). Here are a few ratios that measure the capital adequacy of the banks.

Capital Adequacy Ratio:The capital adequacy ratio has been advanced for ensuring that banks
engross a rational level of losses arisen due to the operative losses and govern the banks internal
capacity to meet the losses -(Aspal & Dhawan, 2016).

Debt-Equity Ratio: Debt-Equity Ratio shows the degree of leverage within the bank. It shows that
how much bank business is financed through equity and how much bank business is financed
through debt (Vaza, 2018).

Advance to Assets Ratio: Advance to Assets ratio is also used for measuring capital adequacy as
it demonstrates the aggressiveness of banks in lending that results in effective profitability(Priya,
2019).

Government securities to total investments: The crucial indicator shows the banks' risk-taking
ability. It is the strategy of bank to get high profits, low profits or high risks, or low risk(Aspal &
Dhawan, 2016).

2.4.2 Asset Quality

It is the second component of CAMELS that is the crucial parameter for gauging the
strength of the bank all over the world. The basic motto behind the measurement of asset quality
is ascertaining the non-performing assets' component as a percentage of the total number of assets
(Vaza, 2018). The ratios that are necessary for assessing the quality of the asset are given here.

Net NPAs to Total Assets: This ratio is used to disclose the banks’ effectiveness to assess the credit
risk and recover the debts(Priya, 2019).

Net NPAs to Net Advances:This ratio is considered as the most useful and standard measure of
assets quality, which is used to measure the net non-performing assets, which are the percentage
to net advances(Aspal & Dhawan, 2016).
 28

Total Investments to Total Assets:This ratio is used to specify the extent to the assets engagement
in investment as alongside advances(Vaza, 2018).

Percentage Change in NPAs:This measure is used for tracking the movement in Net NPAs over
past years. If there is a higher reduction in the net NPA level, then the bank will perform
better(Priya, 2019).

2.4.3 Management Soundness

It is the third component of CAMELS that involves the subjective analysis for measuring
the effectiveness and efficiency of management (Priya, 2019). The ratios that are used for
evaluating management efficiency are given here.

Total Advances to Total Deposits:This ratio is used to measure the ability and efficiency of
management of banks for converting the deposits that are available in the bank excluding other
types of funds such as equity capital into the high earning(Aspal & Dhawan, 2016).

Profit per Employee:This ratio shows the surplus earned per employees. This ratio is attained
when profit after tax earned is divided by the total number of employees working in the bank(Vaza,
2018).

Business per Employee:This is another ratio to measurement the management soundness of the
banks. This ratio shows the productivity of the human force of bank. This tool is used for
measuring the employees' efficiency to generate business for the bank(Priya, 2019).

Return on Net worth:This is also used to measure banks profitability. It is expressed in the form
of a percentage of Average Net Worth(Aspal & Dhawan, 2016).

2.4.4 Earnings

The earning quality is a crucial criterion that measures the banks' ability to earn in a
consistent manner. It primarily measures the banks' profitability and elaborates its growth and
sustainability in earning in the near future(Vaza, 2018). The following ratios are used to measure
the earning ability of banks and financial institutions

Operating Profit to Average Working Funds:This ratio shows how banks get profit from its
operations for money spent in the form of the working fund(Priya, 2019).
 29

Percentage Growth in Net Profit:This ratio is the percentage change in the net profit over last
year.

Net Profit to Average Assets:This ratio is used to measure the return on assets employed or it is
used to measure the competence in the operation of assets(Aspal & Dhawan, 2016).

2.4.5 Liquidity

Liquidity is another important asset that measures two aspects. First, the rating system
focuses on the interest rate risk, and secondly, liquidity management is analyzed in a detailed
way(Priya, 2019). The ratio to measure liquidity are given here.

Liquid Assets to Demand Deposits: This ratio issued to measure the banks' ability to encounter
the depositors' demand in a specific year (Vaza, 2018).

Liquid Assets to Total Deposits: This ratio is used to measure the available liquidity to the total
deposits in the financial institutions (Aspal & Dhawan, 2016).

Liquid Assets to Total Assets: This ratio is used for measuring the complete liquidity position of
the bank(Vaza, 2018).

2.4.6 Sensitivity

It is the last component of CAMELS that measures the sensitivity to market risk. This
measurement is complicated, and still, it is growing, sensitivity to the market captures the impact
of unexpected shifts in the interest rate(Vaza, 2018).

In the CAMELS rating, the lower the score is good such as the score of two or less than it,
while the score of three or more is the bad sign of business financial performance. CAMELS ratio
analysis is a comprehensive method for assessing the risks that are based on individual banks. It is
mostly used by rating agencies and banking supervisors(Aspal & Dhawan, 2016).

2.5 Determinants of commercial banks’financial performance

2.5.1 IV1:Bank Management Efficiency (Internal Variable)

Banton (2019) defined that “efficiency is the level of performance that shows the least
amount of input for achieving the highest amount of output.” Spacey (2018) defined “management
efficiency is the output that is created by the management team within the business.”It is linked
 30

with the capital that the company direct and expenses that the company expands. The common
examples of management efficiency are (i) allocative efficiency, (ii) return on capital, (iii)
productivity, (iv) resource efficiency, (v) process efficiency, and (vi) cost efficiency. The
allocative efficiency deploys resources for creating value within the firm. The failed strategy can
reduce organizational efficiency by spending on activities that have no value. Return on capital is
the operating income that the organization earns in relevance with the capital employed.
Productivity is the output of the work done in the firm by the employees under the management
team. Resource efficiency is the use of various resources such as land, energy, material, and parts
without waste. Process efficiency is that amount of expenses, labor, and time that is consumed by
the process that is linked with its outputs. Lastly, cost efficiency is linked to business outputs and
goals(Spacey, 2018).

Management efficiency is the most important factor of CAMELS framework that measures
the performance of banks. The management efficiency of banks involves the banks' administrative
abilities to react to diverse circumstances. This term involves the management capability to
generate businesses and maximize their profits. The administrative proficiency is the focal term
that is used for the banks' management efficiency that indicates the banks capacity for increasing
its benefits and decreasing its costs within the given scenario. Effectiveness and efficiency became
the rule within the banks so that the employees' productivity can be increased. Currently, banks
have increased their working hours as well as implemented new technology that has improved
their operating system. Management efficiency is crucial for bank performance. These qualitative
factors are an application within the institutions and use it as an indicator to manage efficiency.
Earnings per employee, expense ratio, and loan size are alternatives for measuring management
efficiency. With the use of technology, they deliver quick services within a short time, attract
customers, and compete with them comfortably and quickly. This parameter has been taken from
the CAMELS model, and it has a crucial position that shows that bank management efficiency has
utmost importance for financial performance. The banks take complex decisions based on risk
perfection. The administrative effectiveness is measured by the Assets turnover. When there is a
higher proportion, then administration efficiency is higher. Effective management is needed for
the productivity and success of the financial organization. It is complicated to give any comment
that is linked with management efficiency based on the quantitative data, as it is qualitative in
nature. Management efficiency is crucial to ensure the stability and strength of banks. Within the
 31

banks' management, assets efficiency is crucial because it is directly linked with the debt
serviceability of the firm. The effective deployment of commercial resources can give more profits
within the organization(Ishaq, Karim, Zaheer, & Ahmed, 2016).

Zagherd and Barghi (2017) researched on the Iranian banking industry and evaluated the
performance of banks using the CAMELS framework. The research collected data from 2007 to
2015 and used financial statements for data extraction. The study outcomes reflected that capital
adequacy, management quality, asset quality, sensitivity to the market, and liquidity quality have
a significant positive relationship with the financial performance that is expressed in term of ROE
of banks. On the other hand, the study showed that earning quality has no relationship with the
ROE of banks of the Iranian banking industry. Muhmad and Hashim (2017) explored the
interaction effect of CAMEL framework and corporate governance on the performance of the
bank. The study was conducted on the Malaysian banks and taken data from the year 2008 to 2012.
The study outcomes reflected that earning ability, management efficiency, capital adequacy, and
liquidity in the firm has a significant relationship with the performance of banks when it interacts
with corporate governance practices. The study findings also reflected that management efficiency
has a strong relationship with the financial performance of Malaysian banks. The study gives
vision to investors, depositors, stakeholders, and researchers to increase bank management
efficiency to improve businesses productivity.

Ebrahimi, Bahraminasab, and Fard (2017) researched on the listed banks of the Tehran
Stock Exchange. The study used CAMELS approach to explore the financial performance of the
banks. The study was conducted on the 14 listed banks, and the secondary data was collected from
the financial reports from 2010 to 2015. The study used multivariate regression analysis to give
the study findings. The findings of the study showed that assets quality and capital adequacy have
a significant positive relationship with the financial performance of the firm and liquidity has a
significant negative relationship with the financial performance of Tehran stock exchange. The
study showed that management efficiency and earning ability have no relationship with the
financial performance of the banks. Shamim, Abdulla, and Sakhi (2018) researched on the macro-
economic factors that drive profitability in Saudi Arabia. The study was conducted on the 12 local
banks during the period of 2009 and 2015. The outcomes reflected that bank size, liquidity, and
efficiency has a significant positive impact on the banks' profitability.Sathyamoorthi, Mapharing,
 32

Ndzinge, Tobedza, and Wally-Dima (2017) investigated the three listed banks of Botswana during
the period of 2011 to 2015 by using CAMEL framework. The study findings showed that
management efficiency and earning ability have no significant impact on financial performance.

2.5.2 IV2:Bank Earnings Ability (Internal Variable)

Ahsan (2016) defined earning ability, as “it is the company's ability to generate profit and
productivity.” It is the ability to generate profit from its associated operations. The analysts and
investors calculate earning power for determining that either the company is worth investing or
not. The earning ability is referred to as the person's ability to generate earnings in return from the
services and goods.Saif-Alyousfi, Saha, and Md-Rus (2017) defined earnings, as “the income
earned from all the extraordinary, non-traditional, and operational sources that constitute the
banks earning.”The banks’ efficiency is measured in term of the capital adequacy for covering all
the potential losses and pay off the dividends. Desta (2016) defined that “earning ability is the
ability to earn a good return on the assets that enable the institutions for fund expansions, increase
capital, and remain competitive.” The ratings of the institutional earning depend on the levels of
earnings, such as stability and trends. It is the ability to provide adequate capital by using retained
earnings. It also focuses on the sources and quality of earnings. The level of expenses is linked
with the operations of the firm. The adequacy of the forecasting processes, budgeting systems, and
management information have vast importance in the organization. The adequacy of provisions is
used for maintaining the allowance for the loans and other relevant valuation allowance accounts.
The banks earning ability also focuses on earning exposures to market risks, such as foreign
exchange, price risks, and interest rates (Ghasempour & Salami, 2016).

Earnings ability is another crucial factor of CAMELS framework. The banks' earning
ability shows the banks' capability for earning on a regular basis. It shows the progress and
sustainability for future earnings. The earnings quality is an important factor that shows that banks'
aptitude for consistent earning. It primarily shows the banks' profitability. The acknowledged
measure for the banks' execution is productivity. Various indicators to measures the banks earning
ability such as ROA and ROE. The amount of profit that is produced within the company within a
specific period is mostly presented in the form of the quarter and annual basis. Ordinarily, profit
shows the after-tax income. The business income is the determinant of share prices. Firms need to
increase their earnings and profitability for avoiding capital bases loses. It is the quantitative
 33

measure of the administrations' capacity for using stakes for making esteem for shareholders and
maximize capital soundness. The profitability investigation is critical as it focuses on the
enhancement of earning streams. The productive banks have the major tendency for acquiring high
bank appraisals, and bankrupt banks face issues related to satisfactory benefits. The earning ability
is the profit earning capacity that is the necessary element, which contributes to firm survival. The
perpetual existence of the firm focuses on the profit earning capacity of the organization (Ishaq et
al., 2016).

Lelissa and Kuhil (2018) explored the bank-specific factors on the performance of
commercial banks of Ethiopia. The study used secondary data from 1990 to 2015 for measuring
the impact of bank-specific internal factors on the banks' productivity. The outcomes of the study
reflected that bank-specific factors such as management efficiency and earning ability have a
significant positive impact on the productivity of the banks. Kengatharan (2018) examined the
association between the CAMELS rating system and commercial banks' performance that are
located in Sri Lanka. The study collected data from 2011 to 2016 from the annual reports of ten
commercial banks. The study outcomes reflected that capital adequacy and managerial efficiency
have a significant positive relationship with the financial performance of the banks while the
earning ability, assets quality, and liquidity have not any significant relationship with the
commercial banks' financial performance and productivity. Ullah (2016) stated that internal
factors have a strong influence on the profitability of the banking industry in the GCC countries,
while the external factors have no influence.

Desta (2016) researched on the financial performance of the African banks. The study was
conducted on the seven banks from the thirty banks because the selected banks were considered
best banks as per Global Finance Magazine. The data was collected from the financial statement
of African banks from 2012 to 2014. The study applied the CAMELS framework for measuring
the banks' productivity. The study findings reflected that capital adequacy and earnings ability
have a strong positive relationship with the banks' profitability in Africa while the asset quality,
liquidity, and management efficiency have less satisfactory, critically deficient, or no relationship
with the banks' financial performance.Echekoba, Egbunike, and Ezu (2014) findings reflected that
the liquidity has a significant impact on bank profitability, but earning ability, management
efficiency, capital adequacy, and asset quality have no relationship with financial performance.
 34

2.5.3 IV3: GDP (External Variable)

Chappelow (2019) defines that “GDP (Gross domestic product) is the total market value
of all the services and goods developed within the borders of the country within the specific time
period”.According to Lelissa (2014), GDP is defined as “the broader measure of overall domestic
productions as its functions as a scorecard for the financial health of the company.”Amadeo
(2019) defined that “GDP is the total value of everything that is produced or developed within the
country.” Any production within the country border come under the umbrella of GDP. Bondarenko
(2019) defines that “GDP is the total market value of goods that are a product within the country's
economy.”In economics, the final users of goods are divided into three groups, such as
government, businesses, and households. The way GDP is produced known as the expenditure
approach that is made by the users' groups. Therefore, GDP is defined in term of the combination
of consumption, investment, government spendings, and net exports.

Bami (2014) measured the profitability of commercial banks located in Albania. The study
collected the data of the period 2005 to 2014 from the five banks through the annual reports of
each bank. The study results stated that GDP is positively linked with the profitability of Albanian
banks. The coefficient of 0.014 in regression model reflects that GDP is the significant predictor
of profitability of banks. On the other hand, inflation has a non-significant relationship with the
banks' profitability of Albania.Haidary and Abbey (2018) researched on the commercial banks in
Afghanistan. The study was conducted on the 15 banks that were operating within Afghanistan.
The data was taken from the period of 2012 to 2016 to analyze the internal as well as external
variables of banks' financial performance. The study outcomes reflected that capital adequacy,
management efficiency, and asset quality have a significant positive impact on the banks'
profitability. The external variable, i.e., GDP, has an insignificant impact on the financial
performance of commercial banks located in Afghanistan.

Ongore and Kusa (2013) reflected that management efficiency has a positive impact on the
profitability of commercial banks in Kenya. The external factors such as GDP and the inflation
rate has a strong negative correlation with the stock return. Al-Tamimi and Hussein (2010) showed
that GDP is the significant determinants of the performance of conventional and Islamic banks of
UAE. Lelissa (2014) researched on the Ethiopian commercial banks and stated that GDP growth
 35

rates have not a significant impact on financial performance while inflation is the significant
determinant of financial performance.

2.5.4 IV4: Inflation Rate (External Variable)

Chen (2019) defined that “inflation is the quantitative measure of the rate at which the
price level of the goods and services is increased within the economy within a specific time.” It is
the constant increase in the price levels where the unit of currency for the products is more than
the prior period. Amaded (2019) defined that “inflation is the increase in goods and service prices
within a specific time. It means the cost of living becomes high within the country.” The purchasing
power of every unit of currency becomes reduced. Fama (2018)defined that “inflation rate is the
percentage at which the currency of the country is devalued within the specific time period.” This
devaluation reflects the increase of consumer price index within a specific time. It is the rate at
which currency is devalued that causes the general prices of the consumer goods to maximize
relevance to the change in the value of the currency(Fama, 2018).

Abugamea (2018) researched on the profitability determinants in the context of Palestine.

The study used the balance sheet from 1995 to 2015 to explore the determinants of profitability.
The study measured the profitability in term of ROA, ROE, and NIM. The internal determinants
in the study were asset size, loans, capital, and deposits, while external determinants were GDP
and inflation rate. The study outcomes reflected that size, capital, and loan are positively linked
with productivity, and deposits are negatively related to productivity. On the other hand, GDP and
inflation rate have no significant relationship with the banking sector of Palestine.Antoun, Coskun,
and Georgiezski (2018) measured the bank-specific, industry-specific, and macroeconomic
determinants of financial performance. The study researched on the Banks of Central and Eastern
Europe and the data was collected through Bank Scope database from 2009 to 2014. The study
outcomes reflected that inflation has a positive impact on the earnings and profitability of the firm.

Fani, Khan, Kumar, and Pk (2018) researched on the internal as well as external factors on
the banks' performance. The study targeted all the commercial listed banks of Pakistan. The study
targeted all the internal factors of the CAMELS framework and external factors such as Stock
market performance, GDP, and inflation. The study was conducted by taking a sample from 2012
to 2016. The study employed a Feasible Generalized Least Squares (FGLS) panel data model in
this research. The study outcomes reflected that the CAMELS framework factors such as asset
 36

quality, liquidity, and capital adequacy have an indirect but strong relationship with the financial
performance of the banks. The management efficiency has a positive relationship with the
performance of the listed banks of Pakistan. The external factors such as inflation have a strong
negative relationship with the performance of the banks and GDP, and stock market performance
has a strong positive correlation with the performance of banks (Fani, Khan, Kumar, & Pk, 2018).

Solomon (2018) researched on the banking sector of Ethiopia and extensively explained
the factors associated with the financial performance of private-owned and state-owned
commercial banks. The study used CAMELS approach model to explore the internal performance
indicators. The study used judgmental sampling technique to collect data from commercial banks
during the period from 2004 to 2016 for exploring the relationship among study variables. Side by
side the internal variables, the study also measured the external variables such as inflation rate and
GDP. The study outcomes reflected that capital adequacy, management efficiency, earning ability,
asset quality, and sensibility have a significant positive relationship with financial performance
except for liquidity measures. Based on regression analysis, the inflation rate has a significant
positive relationship with the performance of banks, while GDP has no relationship with the
financial performance of the Ethiopian state-owned and privately owned banks .

Mousavi and Karshenasan (2017) researched on the values of bank shares in the Tehran
Stock Exchange. The study was conducted on 25 banks, and the data was collected from the period
of 2008 to 2014. The study outcomes reflected that bank performance, bank size, credit risk, and
the inflation rate has a positive impact on the market value of bank shares. Ifeacho and Ngalawa
(2014) outcomes reflected that interest rate has a significant relationship with the stock return
while, inflation rate, unemployment rate, and other macroeconomic variables have a non-
significant relationship with the performance of South African banking sector.

2.5.5 IV5: Interest Rate (External Variable)

Banton (2019) defines that “interest rate is the amount that lender chargers for using
assets that are expressed in the form of percentages.” The interest rate is noted on a yearly basis
and is known as the annual percentage rate. The borrowed assets involve consumer goods, cash,
and larger assets such as building and vehicle. Amadeo (2019) defines “interest rate is the
percentage of principal charged by the lender for using its money.” The principle is the amount
of money that is lent. Banks pay an interest rate on deposits. The banks apply an interest rate to
 37

the completely unpaid portion of the loan or on the credit card balance. Interest rates are
competitive and are not the same.

Rehman, Khan, Khan, and Rahman (2018) researched on the banking sector of Pakistan to
maintain financial stability and control the negative shock. The study collected the data from 2007
to 2015 and used a fixed-effect model to study the impact of internal and external factors on the
profitability of the banks. The study findings showed that the internal factors such as asset
composition and bank size affect the banks' overall profitability, but the external factors such as
interest rate and GDP are the positive determinants of banks' profitability. Mujuka (2018)explored
the factors affecting the financial performance of commercial banks in the context of Kenya. The
target population of the study was 88, and the sample size was 72. The study outcomes reflected
that interest rate and inflation rate have a positive association with the Kenyan banks'
profitability.Ayub and Masih (2013) researched the exchange rate, interest rate, and stock prices
of Islamic banks by using panel data analysis. The study reflected that the exchange rate has a
positive impact on stock prices, while the interest rate has no impact on the stock prices of Islamic
banks.Liu and Pariyaprasert (2014) stated that the interest rate has a significant impact on the
financial performance of banks in the Chinese stock exchange.

2.5.6 IV6: Oil Price (External Variable)

Griffin and Teece (2016) define oil price as “the spot price of one barrel of the benchmark
crude oil, which depends on its location, grade, and content of sulfur mixed in it”. The oil price
can be measured with the help of balance exits in its supply and demands. Thorbecke (2019)
defines oil prices as “the determinant of global demand and supply”. Financial growth is the
utmost factor that affects petroleum products, such as the demands of crude oil.Oil prices come
from the import of crude oil that is obtained by dividing the value by volume. Oil prices play a
crucial role in the global economy. The oil prices have vast demand in the world that is why small
fluctuations in the oil prices have an evident impact on the global economy. Oil demands depend
on macroeconomic conditions in the world.

Lee and Lee (2019) researched on oil prices and Chinese banking performance. The study
used the CAMEL approach as an indicator in China from 2000 to 2014. The study outcomes
reflected that oil prices have a significant negative impact on the performance of banks. Al-Shami
and Ibrahim (2013) explored the macro-economic indicators such as interest rate, inflation rate, oil
 38

prices, money supply, and unemployment rate on the Kuwait stock market. The study collected
data during the period of 2001 to 2010. The study findings showed the positive relationship
between the interest rate and stock return and the negative relationship of stock return with the
inflation rate and oil prices in Kuwait stock market.In'airat (2018) stated that oil prices have an
insignificant impact on the stock market prices in Saudi Arabia. Er and Vuran (2012) researched
on the factors such as exchange rate, interest rate, and oil prices that affect the stock return in the
developed and developing countries. The study used the time series and cross-sectional method to
support the research objectives. The study was conducted on 64 firms from 2003 to 2007. The
study outcomes reflected exchange rate has a positive impact on the stock returns, while interest
rate and oil prices have a negative impact on the stock returns. Arouri and Fouquau (2009) explored
the long-term association between the GCC stock markets and oil price. The study outcomes reflect
that oil prices have a significant impact on the stock returns of GCC markets.

2.6 Summary

Banking industry of Saudi Arabia has been discussed within this chapter along with the
introduction of the selected banks that have been used as the sample of the study. Firms
profitability has been discussed and is explained. Moreover, several theories have been discusses
in this chapter i.e. modern portfolio based theory, arbitration theory and resource based theory.
This chapter has further explored the theoretical background and empirical evidence on the micro-
economic factors using CAMEL framework and macro-economic factors. Banks around the globe
use CAMEL system as an international rating system for rating the performance of financial
institution. CAMEL includes six factors such as Capital Adequacy, Asset Quality, Management,
Earning, Liquidity, and Sensitivity. The framework provides essential elements or variables to
measure the performance of banks that help to rate financial institutions. Capital adequacy is
measured using capital trends, Asset Quality is measured by rating investment risk factors,
Management involves the effectiveness of management to react to financial stress, Earnings show
the returns to help businesses expand, Liquidity measures the ability of the company to convert its
assets into cash, and finally, Sensitivity helps to measure the potential risks which can affect the
performance of banks (Ahsan, 2016).

The current research is using the above-mentioned variables in the CAMEL framework. Using the
CAMEL framework, the current research uses variables such as Management’s Efficiency and
 39

Earning Ability; however, other variables are not used in the research such as liquidity, asset
quality, and sensitivity in measuring the financial performance of banks in Saudi Arabia. The
reason for not using other variables is time constraints involved in completing the research in due
date, secondly there were constraints was access to the adequate data as the key information
required for other factors of CAMEL framework was not accessible and lastly only that data is
utilized that was easily available from the annual reports of the banks and bank websites has been
used in a manner that research quality remain intact.
 40

2.7 Literature Matrix

IVs Bank Bank GDP Inflation Interest Rate Oil Price

Management Earnings Rate
Efficiency Ability
(Zagherd & Barghi, 2017) X X
(positive) (no
relationship)
(Muhmad & Hashim, X X
2017) (positive) (positive)
(Ebrahimi, Bahraminasab, X X
& Fard, 2017) (no (no
relationship) relationship)
(Shamim, Abdulla, & X
Sakhi, 2018) (positive)
(Sathyamoorthi, X X
Mapharing, Ndzinge, (no (no
Tobedza, & Wally-Dima, relationship) relationship)
2017)
(Lelissa & Kuhil, 2018) X X
(positive) (positive)
(Kengatharan, 2018) X X
(positive)
 41

(no
relationship)
(Desta, 2016) X X
(no (positive)
relationship)
(Echekoba, Egbunike, & X X
Ezu, 2014) (no (no
relationship) relationship)
(Ullah, 2016) X X
(positive) (positive)
(Haidary & Abbey, 2018) X X
(positive) (no
relationship)
(Bami, 2014) X X
(positive) (no
relationship)
(Ongore & Kusa, 2013) X X X
(positive) (negative) (negative)
(Al-Tamimi & Hussein, X -
2010) (positive)
(Lelissa, 2014) X X
(positive)
 42

(no
relationship)
(Abugamea, 2018) X X
(no (no
relationship) relationship)
(Antoun, Coskun, & X
Georgiezski, 2018) (positive)
(Fani, Khan, Kumar, & X X X
Pk, 2018) (positive) (positive) (negative)
(Solomon, 2018) X X X X
(positive) (positive) (no (positive)
relationship)
(Mousavi & Karshenasan, X
2017) (positive)
(Mujuka, 2018) X X
(positive) (positive)
(Rehman, Khan, Khan, & X X
Rahman, 2018) (positive) (positive)
(Ayub & Masih, 2013) X
(no
relationship)
 43

(Liu & Pariyaprasert, X

2014) (positive)
(Ifeacho & Ngalawa, X X
2014) (no (positive)
relationship)
(Lee & Lee, 2019) X
(negative)
(Al-Shami & Ibrahim, X X X
2013) (negative) (positive) (negative)
(Er & Vuran, 2012) X X
(negative) (negative)
(Arouri & Fouquau, 2009) X
(negative)
(In'airat, 2018) X
(no
relationship)
(Muhmad & Hashim, X
2015) Weak
relationship
(Sahyouni & Wang, 2019) X
Negative
relationship
 44

(Pilar, Alcobera, Diego, X

Ausinac, & Illueca, 2019) positive
(Wachira, 2010) X X
Positive Positive
 45

Chapter 3:

Research methodology
The proposed chapter provides a description of the methodology of the proposed study, which
includes the research methodology used for the collection of data that helps to investigate the proposed
research problem. This chapter will give detailed information about research design, study population,
sample size, and selection, sampling techniques and procedure, data collection methods, data collection
instruments, validity and reliability, the procedure of data collection, data analysis, and measurement of
variables. Both qualitative and quantitative research methodology is the most commonly used measure of
research design in scientific research where data can be collected using two sources, which include (a)
primary data and (b) secondary data.

3.1 Qualitative Research & Quantitative Research

The distinction between quantitative and qualitative data is that in qualitative data, which allows
understanding complex details and variables. Similarly, quantitative data is the type of data that deals
comprehensively with numerically described results in terms of objects variables or statistical values. It
involves using computational and statistical techniques and collects the relevant data from a number of
individuals in the sample (Bryman, 1984).

3.1.1 Objectives from Quantitative Research (250-300 words; state your own research objectives)
The current study uses descriptive research design that includes quantitative data collected from
secondary sources to measure the relationship of banks’ financial performance with internal and external
factors in the listed banks in Saudi Arabia. The independent variables, which are used in this research
design, are including Management’s Efficiency, Earnings Ability, which are referred to as the internal
independent variables. The external independent variables include inflation, GDP, and Interest Rates. The
data investigated will be between the years 2005 to 2011 that helps to measure the firm’s performance in
the time selected. The firm’s performance is calculated in terms of Return on equity (ROE)) as an indicators
of financial performance in Saudi based banks. This study utilizes purely quantitative methods, which is
why, the annual reports of financial institutions listed on Tawadul. The research will use data from 8 banks
excluding one bank. Therefore, the research will present analysis of relationship of ROE with other
variables.

3.1.2 Quantitative Research Method Used

The following research will use quantitative research methodology that allows us to research or
investigate a certain phenomenon and gathers quantifiable data. The current research uses a secondary
 46

method of data collection that is collected from the financial statements showing financial performance and
factors affecting bank’s financial performance.

3.2. Target Population (300 words)

Vonk, (2017) defined target population as “The group of people to whom we want our
research results to apply.” Further she defined study population as “The people who meet our
operational definition of the target population.” The study area of the research covers the
population of Saudi Arabia from all genders and ages. Different banks have been selected as the
target population that are listed in the Stock exchange of Saudi Arabia.

3.2.1 Sample Selection and Size

Hamed Taherdoost (2017) defines the sampling method involves selecting a representative of the
population and collection data from them as research information. On the other hand, the sample is a subset
of data that belongs to a population Sample serve a representative of the population. In every sample, similar
attributes or traits of a population are discussed. The most important step is to select an appropriate sampling
strategy that helps to select the right sample from the population, which is why, different sampling
techniques and methods are used in a financial or scientific research that helps researchers to minimize their
cost and produce accurate data more efficiently. The most common and frequently used sampling
techniques include probability sampling and non-probability sampling. In the current research, a sample of
total 8 banks is included and one bank is excluded due to its listing in Tawadul Saudi Arabia.

The proposed study uses a sample size of 359 that includes all the banks listed on Tawadul database.
Tawadul is the registered entity in the Kingdom of Saudi Arabia (KSA) that has the authority to act as
securities exchange. The sample includes criteria related to financial institutions and banks in the KSA,
which constitute the financial sector of the country belonging from financial sector, which includes financial
institutes and banks. The selected sample for the proposed study includes companies belonging to listed
banks on Tawadul in the KSA The financial data collected in this research comes from the annual report
of these companies has been gathered and analyzed. Sample of 66 years data has been analyzed from the
year 2005 to 2016. Bank A, which is ALAWWAL Bank (Saudi Equity Fund), is removed from the data
bank as it was listed in stock exchange in 2011. All the other banks listed in Tawadul are included in the
data sample.

3.2.2 Research Instrument & Sampling Technique

Primary research involves questionnaire or a survey but this research is based upon secondary data
therefore, no questionnaire or survey has been used for the current research. The research is using secondary
 47

data as the source of analyzing data taken from the financial statements of banks. Sampling can be divided
into two sections a) Probability Sampling b) Non-Probability Sampling. There are different types of
probability sampling techniques such as simple random sampling, systematic sampling, stratified sampling,
and clustered sampling. Different type of non- probability sampling are convenience sampling, quota
sampling, purposive sampling and snowball sampling. The following research has used convenience
sampling technique which is the easiest method to do sampling and is based upon the availability,
willingness and ease of access to data.

3.3 Sources of Data

In both quantitative and qualitative research methodology, however, the study does not use primary
research method and only uses secondary data collection methods such as online sources and company
reports to collect the financial data and figures. Ox and Boeije, (2005) define primary data also referred to
as the first-hand data or original data collected from achieving specific research goal whereas secondary
data is second-hand data which has been previously collected for a different purpose and reused for another
research question. The current study will analyze the performance of financial sector using the secondary
data sources that include financial reports of banks from Saudi Arabia.

3.4 Accounting Measurement

There are a myriad methods to gauge or estimate the performance of financial institutions in Saudi
Arabia listed on Tawadul. However, the proposed research uses CAMEL framework that include six factors
and variables to measure the financial performance of the firms. The data is then exported into SPSS
statistical tool for further analysis. From CAMEL framework, this study uses variables such as
Management’s Efficiency, Earnings Ability of banks in the KSA.

Variables Measurement Scale Information Source

DEPENDENT VARIABLE (DV)

DV1:Financial Performance Return on Equity ROE Annual Reports (Balance Sheet and
(Return on Equity ROE) Income Statement)
(Net Income/Average Shareholder’s
Equity)

Internal Factors
 48

IV1: Management Efficiency Bank Management Efficiency= Annual Report (Balance Sheet and
Interest expenses to total Income Statement)
expenses/interest incomes to total
incomes/total incomes to total
expenses

IV2: Earning ability Earning Ability=Net Profit to Total Annual Report (Balance Sheet and
Assets /Net Profit to Equity Income Statement)

External Factors

CV1: Inflation Rate CPI Formula = Cost of market basket World Bank, (2019)
in a given year/Cost of market basket
at base X 100

CV2: Interest Rates Simple interest = principal x interest World Bank, (2019)
rate x time

IV3: GDP GDP = C + I + G + (X – M) World Bank, (2019)

C = All private consumption/

consumer spending in the economy.
It includes durable goods, non-
durable goods, and services.

I = All of a country’s investment on

capital equipment, housing etc.

G = All of the country’s government

spending. It includes the salaries of a
government employee, construction,
maintenance etc.

NX= Net country export – Net

country import
 49

IV4: Oil Prices Oil price per Gallon World Bank, (2019)

Table 1: Research instruments

3.5 Data Analysis

Data analysis methods provides a justification why data is analyzed and why the data is used as a tool for
analyzing data collected by the researcher arrive at stated research objectives. The analysis part will use (a)
descriptive statistics and b) multiple regression analysis. In this proposed study, secondary data analysis
includes Financial Performance ROE, Management Efficiency, Earning Ability, GDP, Oil Prices, Interest
Rates, and Inflation rate are used related to banks. The data is processed in SPSS tool, which provides
meaningful information about the sample and the measures using charts and graphs of quantitative analysis
of data. OLS multiple regression is also used using predictive variables that helps to measure the impact of
one variable on another.
 50

CHAPTER 4

4. Research Findings and Results

The chapter will include research findings and data analysis results that aims to measure the
financial performance in terms of ROE of the financial institutions in the KSA and relates them
with the independent variables. The annual reports and websites are used by the researchers in
order to generate the presented results. The research uses a quantitative research methodology;
data has been selected for ten years from 2005 to 2016.

4.1 Descriptive Statistics

The following graphs provide information related to descriptive statistics in the form of graph that
shows the performance of various banks selected. The yellow line shows that Bank E shows the
best performance because the dividends yield related to Bank E listed in Tawadul is highest as
compared to other banks. The graphs show time series analysis of dividend yields of all the banks
included in the research; the stats show data from 2005 to 2016. For example, red line shows that
dividents yield analysis of Bank 1 whereas green line shows the financial performance of Bank G.

Profitability Analysis using Stock Return Commented [u1]: Which bank performed better and
why>?

Divident Yield of Banks Listed in Tawadul

8.000
7.000
6.000
5.000
4.000
3.000
2.000
1.000
0.000
9/1/2005
3/1/2006
9/1/2006
3/1/2007
9/1/2007
3/1/2008
9/1/2008
3/1/2009
9/1/2009
3/1/2010
9/1/2010
3/1/2011
9/1/2011
3/1/2012
9/1/2012
3/1/2013
9/1/2013
3/1/2014
9/1/2014
3/1/2015
9/1/2015
3/1/2016
9/1/2016

Bank B BankC Bank D Bank E

Bank F Bank G Bank H Bank I

Profitability Analysis using ROE Commented [u2]: Which bank performed better and
why>?
 51

The following graph figure shows that Bank F shows the highest value of Return on Equity ROE
that is the measure of financial performance of the bank F as compared to other banks in the sample
data. A higher value of ROE means that company’s performance is superior as compared to those
who show a lower value of ROE. The graph below shows that Bank F has the best performance
due to highest values of ROE in the graph as a measure of financial performance. All the other
banks have a lower value of ROE.

ROE of Banks Listed in Tawadul

0.500

0.400

0.300

0.200

0.100

0.000
9/1/2005
3/1/2006
9/1/2006
3/1/2007
9/1/2007
3/1/2008
9/1/2008
3/1/2009
9/1/2009
3/1/2010
9/1/2010
3/1/2011
9/1/2011
3/1/2012
9/1/2012
3/1/2013
9/1/2013
3/1/2014
9/1/2014
3/1/2015
9/1/2015
3/1/2016
9/1/2016

Bank B BankC Bank D Bank E

Bank F Bank G Bank H Bank I

Regression Analysis
Regression analysis done here is useful to explain whether the changes in independent variables
are able to change or associate with the changes in the dependent variable. Such changes will be
observed in three tables including coefficients, ANOVA, and Model Summary. For example, p
value will help to determine whether coefficients are significant or not.

Notes

Output Created 25-SEP-2019 00:24:28

Comments
Input Data C:\Users\user\Desktop\September
19\scenario 1 Lebska Data.sav
Filter <none>
Weight <none>
Split File <none>
N of Rows in Working
359
 52

Data File

Missing Value Definition of Missing User-defined missing values are

Handling treated as missing.
Cases Used Statistics are based on cases with no
missing values for any variable used.

Syntax REGRESSION
/DESCRIPTIVES MEAN STDDEV
CORR SIG N
/MISSING LISTWISE
/STATISTICS COEFF OUTS R
ANOVA CHANGE ZPP
/CRITERIA=PIN(.05) POUT(.10)
/NOORIGIN
/DEPENDENT ROE_DV
/METHOD=ENTER
Management_Efficiency
Earning_Ability GDP_PerCapita
GDP_Growthrate Interest_Rate
Inflation_Rate Oil_Prices
/RESIDUALS DURBIN .

Resources Elapsed Time 0:00:00.02

Memory Required 3556 bytes
Additional Memory
Required for Residual 0 bytes
Plots

[DataSet1] C:\Users\user\Desktop\September 19\scenario 1 Lebska Data.sav

Descriptive Statistics

Mean Std. Deviation N

ROE_DV .0866 .08157 359
Management Efficiency .2381 .15463 359
Earning Ability .1399 .02912 359
GDP_PerCapita .9950 2.74264 359
GDP_Growthrate 3.8944 2.89712 359
Interest_Rate 2.9404 1.47516 359
Inflation_Rate 3.7508 1.73608 359
 53

Oil_Prices 78.3126 22.26315 359

The above table shows descriptive statistics with N as the geometric root of the variable. The table
also shows that values of Standard Deviation and Mean. The standard deviation helps to figure out
how much group members vary from the mean value in the group. The value of Mean represents
the average value of the numbers involved in the data. Descriptive statistics provide the measure
of central tendency, which include mean, median, and mode values. It also includes the measure
of dispersion values such as Standard Deviation. Descriptive statistics help to determine the sample
validity in the research; hence, it is an important part of statistical analysis of variables (Bickel,
2012).In the table, N is the number of included observations. Standard Deviation is a measurement
of dispersion that helps to calculate the variance easily.

Variables Entered/Removed (b)

Variables Variables
Model Entered Removed Method
1 Oil_Prices,
Interest_Rat
e,
Earning_Abi
lity,
GDP_PerC
apita,
. Enter
Inflation_Ra
te,
Manageme
nt_Efficienc
y,
GDP_Growt
hrate(a)
a All requested variables entered.
b Dependent Variable: ROE_DV

The above table shows different variables added and excluded from the statistical tool to achieve
more accurate results using SPSS. For example, independent variables included are Earning
Ability, Oil Prices, GDP, Inflation, and Interest rates that have a direct relationship with the
 54

dependent variable Financial Performance in terms of Return on Equity of banks (ROE).

Model Summary(b)

Change Statistics
Adjusted R Std. Error of R Square
Model R R Square Square the Estimate Change F Change df1 df2 Sig. F Change Durbin-Watson
1
.570(a) .324 .311 .06771 .324 24.077 7 351 .000 2.097

a Predictors: (Constant), Oil_Prices, Interest_Rate, Earning_Ability, GDP_PerCapita, Inflation_Rate,

Management_Efficiency, GDP_Growthrate
b Dependent Variable: ROE_DV

The results of multiple regression yields three tables in addition to a co-efficient table including a
Model Summary Table, which shows the total changing, or variation in the dependent variable.
However, the researchers claim that results of a Model Summary cannot be fully considered
complete to describe the regression analysis of independent and dependent variables. Model
summary provides the value of R and R square that helps to determine the percent of total variance.
For example, the value of R square is .324or 32.4% that is moderately positive but not highly
significant. The square root of R is R and the standard error of the estimate is .06771 or 6.7%.Moreover,
2

the value of Durbin-Watson is 2.097 that is slightly higher than 2 which implies that there exists a
negative autocorrelation. Since DW statistic has a value range of between 0 to 4, a value 2.097
indicates that the statistic values are relatively normal and a value higher than 2.5 would cause a
greater concern.
The table shows the value of R that is .570 which implies there is a variance of 57%among the independent variables
IVs for determining the dependent variable DV.

ANOVA (b)

Sum of
Model Squares df Mean Square F Sig.
1 Regression .773 7 .110 24.077 .000(a)
Residual 1.609 351 .005
Total 2.382 358
a Predictors: (Constant), Oil_Prices, Interest_Rate, Earning_Ability, GDP_PerCapita, Inflation_Rate,
Management_Efficiency, GDP_Growthrate
 55

b Dependent Variable: ROE_DV

ANOVA provides an analysis of variance that uses F statistics value to find out the equality of
means of different groups of data. The value of F statistic helps to the significance of the regression
model. ANOVA table presented above shows a significance value of 0%, which is less than 5%
or 0.005. A significance value less than 5% suggests that the predictor affects the residual variance
in the study. Since p value is less than 5%, it means that independent variables are more
significantly impacting the dependent variable, the Financial Performance (ROE). Therefore, the
values of ANOVA table suggest that regression model is significant to estimate the value of
dependent variable DV.

Coefficients (a)

Unstandardized Standardized
Coefficients Coefficients Correlations

Model B Std. Error Beta t Sig. Zero-order Partial Part

1 (Constant) -.248 .060 -4.158 .000
Management_Efficiency -.051 .034 -.098 -1.512 .131 .225 -.080 -.066
Earning_Ability -.017 .129 -.006 -.135 .893 -.018 -.007 -.006
GDP_PerCapita -.130 .022 -4.357 -5.829 .000 -.025 -.297 -.256
GDP_Growthrate .127 .022 4.521 5.905 .000 -.019 .301 .259
Interest_Rate .031 .003 .564 9.254 .000 .436 .443 .406
Inflation_Rate -.014 .003 -.304 -5.695 .000 -.196 -.291 -.250
Oil_Prices -.001 .000 -.196 -3.097 .002 -.104 -.163 -.136
a Dependent Variable: ROE_DV

In the coefficients table above, the important values to consider are significance level and Beta
values that help to accept of reject the hypothesis. The t value and Beta are important part of this
coefficients table. The t value is also linked with the p value. The value of significance of
Management efficiency is .131 and Earning Ability is .893. Therefore, they are not significant and
cannot be included in our model due to higher value than 5%. The values of all other variables
such as oil prices, inflation rate, interest rate, and GDP are less than 5%, hence, they are significant
in our research.
 56

Residuals Statistics(a)

Minimum Maximum Mean Std. Deviation N

Predicted Value -.0015 .2213 .0866 .04646 359
Residual -.12902 .28510 .00000 .06704 359
Std. Predicted Value -1.895 2.900 .000 1.000 359
Std. Residual -1.905 4.211 .000 .990 359
a Dependent Variable: ROE_DV
 57

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Appendix 1
Regression

Notes

Output Created 25-SEP-2019 00:25:13

Comments
Input Data C:\Users\user\Desktop\September
19\scenario 1 Lebska Data.sav
Filter <none>
Weight <none>
Split File <none>
N of Rows in Working
359
Data File
Missing Value Definition of Missing User-defined missing values are
Handling treated as missing.
Cases Used Statistics are based on cases with no
missing values for any variable used.

Syntax REGRESSION
/DESCRIPTIVES MEAN STDDEV
CORR SIG N
/MISSING LISTWISE
/STATISTICS COEFF OUTS R
ANOVA CHANGE ZPP
/CRITERIA=PIN(.05) POUT(.10)
/NOORIGIN
/DEPENDENT Divident_Yield_DV2
/METHOD=ENTER
Management_Efficiency
Earning_Ability GDP_PerCapita
GDP_Growthrate Interest_Rate
Inflation_Rate Oil_Prices
/RESIDUALS DURBIN .

Resources Elapsed Time 0:00:00.04

Memory Required 3556 bytes
Additional Memory
Required for Residual 0 bytes
Plots
 69

Descriptive Statistics

Mean Std. Deviation N

Divident_Yield_DV2 2.3900 1.62190 359
Management_Efficiency .2381 .15463 359
Earning_Ability .1399 .02912 359
GDP_PerCapita .9950 2.74264 359
GDP_Growthrate 3.8944 2.89712 359
Interest_Rate 2.9404 1.47516 359
Inflation_Rate 3.7508 1.73608 359
Oil_Prices 78.3126 22.26315 359

Correlations

Divident_Yield_ Management_ GDP_PerCapit GDP_Growthra

DV2 Efficiency Earning_Ability a te Interest_Rate Inflation_Rate Oil_Prices
Pearson Correlation Divident_Yield_DV2 1.000 -.379 .208 -.097 -.100 -.366 .023 -.033
Management_Efficiency -.379 1.000 -.229 -.196 -.206 .673 .020 -.119
Earning_Ability .208 -.229 1.000 -.006 -.009 -.043 .024 -.057
GDP_PerCapita -.097 -.196 -.006 1.000 .997 -.034 .290 .454
GDP_Growthrate -.100 -.206 -.009 .997 1.000 -.041 .316 .489
Interest_Rate -.366 .673 -.043 -.034 -.041 1.000 .083 .012
Inflation_Rate .023 .020 .024 .290 .316 .083 1.000 .524
Oil_Prices -.033 -.119 -.057 .454 .489 .012 .524 1.000
Sig. (1-tailed) Divident_Yield_DV2 . .000 .000 .034 .029 .000 .332 .266
Management_Efficiency .000 . .000 .000 .000 .000 .350 .012
Earning_Ability .000 .000 . .454 .433 .207 .328 .141
GDP_PerCapita .034 .000 .454 . .000 .259 .000 .000
GDP_Growthrate .029 .000 .433 .000 . .220 .000 .000
Interest_Rate .000 .000 .207 .259 .220 . .059 .407
Inflation_Rate .332 .350 .328 .000 .000 .059 . .000
Oil_Prices .266 .012 .141 .000 .000 .407 .000 .
N Divident_Yield_DV2 359 359 359 359 359 359 359 359
Management_Efficiency 359 359 359 359 359 359 359 359
Earning_Ability 359 359 359 359 359 359 359 359
GDP_PerCapita 359 359 359 359 359 359 359 359
GDP_Growthrate 359 359 359 359 359 359 359 359
Interest_Rate 359 359 359 359 359 359 359 359
Inflation_Rate 359 359 359 359 359 359 359 359
 70

Oil_Prices 359 359 359 359 359 359 359 359

Variables Entered/Removed (b)

Variables Variables
Model Entered Removed Method
1 Oil_Prices,
Interest_Rat
e,
Earning_Abi
lity,
GDP_PerC
apita,
. Enter
Inflation_Ra
te,
Manageme
nt_Efficienc
y,
GDP_Growt
hrate(a)
a All requested variables entered.
b Dependent Variable: Divident_Yield_DV2

Model Summary(b)

Change Statistics
Adjusted R Std. Error of R Square
Model R R Square Square the Estimate Change F Change df1 df2 Sig. F Change Durbin-Watson
1 .493(a) .243 .228 1.42471 .243 16.136 7 351 .000 .301

a Predictors: (Constant), Oil_Prices, Interest_Rate, Earning_Ability, GDP_PerCapita, Inflation_Rate,

Management_Efficiency, GDP_Growthrate
b Dependent Variable: Divident_Yield_DV2

ANOVA(b)

Model Sum of df Mean Square F Sig.

 71

Squares

1 Regression 229.276 7 32.754 16.136 .000(a)

Residual 712.459 351 2.030
Total 941.735 358

a Predictors: (Constant), Oil_Prices, Interest_Rate, Earning_Ability, GDP_PerCapita, Inflation_Rate,

Management_Efficiency, GDP_Growthrate
b Dependent Variable: Divident_Yield_DV2

Coefficients(a)

Unstandardized Standardized
Coefficients Coefficients Correlations

Model B Std. Error Beta t Sig. Zero-order Partial Part

1 (Constant) 6.442 1.253 5.141 .000
Management_Efficiency -2.863 .716 -.273 -3.998 .000 -.379 -.209 -.186
Earning_Ability 7.097 2.720 .127 2.609 .009 .208 .138 .121
GDP_PerCapita 1.515 .468 2.563 3.240 .001 -.097 .170 .150
GDP_Growthrate -1.569 .454 -2.803 -3.460 .001 -.100 -.182 -.161
Interest_Rate -.238 .071 -.216 -3.348 .001 -.366 -.176 -.155
Inflation_Rate .138 .053 .148 2.616 .009 .023 .138 .121
Oil_Prices .005 .005 .074 1.105 .270 -.033 .059 .051

a Dependent Variable: Divident_Yield_DV2

Residuals Statistics(a)

Minimum Maximum Mean Std. Deviation N

Predicted Value .2217 3.9694 2.3900 .80027 359
Residual -2.94222 4.33331 .00000 1.41071 359
Std. Predicted Value -2.709 1.974 .000 1.000 359
Std. Residual -2.065 3.042 .000 .990 359
a Dependent Variable: Divident_Yield_DV2

Descriptives
 72

Notes

Output Created 25-SEP-2019 00:26:45

Comments
Input Data C:\Users\user\Desktop\September
19\scenario 1 Lebska Data.sav
Filter <none>
Weight <none>
Split File <none>
N of Rows in Working
359
Data File
Missing Value Definition of Missing User defined missing values are
Handling treated as missing.
Cases Used All non-missing data are used.
Syntax DESCRIPTIVES

VARIABLES=Management_Efficiency
Earning_Ability GDP_PerCapita
GDP_Growthrate Interest_Rate
Inflation_Rate Oil_Prices ROE_DV
Divident_Yield_DV2
/STATISTICS=MEAN STDDEV MIN
MAX .

Resources Elapsed Time 0:00:00.00

[DataSet1] C:\Users\user\Desktop\September 19\scenario 1 Lebska Data.sav

Descriptive Statistics

N Minimum Maximum Mean Std. Deviation

Management_Efficiency 359 .02 .65 .2381 .15463
Earning_Ability 359 .08 .28 .1399 .02912
GDP_PerCapita 359 -4.79 6.70 .9950 2.74264
GDP_Growthrate 359 -2.06 10.00 3.8944 2.89712
Interest_Rate 359 2.00 5.50 2.9404 1.47516
Inflation_Rate 359 .48 6.10 3.7508 1.73608
Oil_Prices 359 37.04 140.00 78.3126 22.26315
ROE_DV 359 .00 .46 .0866 .08157
Divident_Yield_DV2 359 .00 7.23 2.3900 1.62190
 73

Valid N (listwise) 359