Research Article: Ishtiaq Ahmad Bajwa 2019 Vol 23 Issue 5 ✓ Solved

Source Research Articleishtiaq Ahmad Bajwa 2019 Vol23 Issue5 Ass

Source: Research article: Ishtiaq Ahmad Bajwa, 2019 vol:23 issue:5, Assessment of credit risk management of Saudi banks. Go through the attached research paper and answer the following questions. (Answer should be approximately in 1200 words.) 1. Discuss Exposure of Saudi banks to credit risk 2. As per the article do you think that Saudi banks capital adequacy is sufficient to meet the Basel III requirement? Discuss your points 3. The researchers of the paper have applied financial ratio analysis to analyze 12 Saudi banks. Suggest the researchers any other approach/method to measure credit risk and discuss why this method should be used? 4. In the light of present COVID pandemic, which has liquidity impact on Saudi economy, discuss on the basis of your understanding of Saudi financial system, strength and weakness of Saudi banks to fight the upcoming challenges.

Sample Paper For Above instruction

Introduction

The banking sector in Saudi Arabia plays a vital role in supporting the country’s economic growth and stability. With a rapidly expanding financial market, banks are exposed to various risks, particularly credit risk, which can significantly impact their balance sheets and overall financial health. The research article by Ishtiaq Ahmad Bajwa (2019) offers an in-depth analysis of credit risk management practices among Saudi banks, emphasizing their exposure levels, capital adequacy, and risk measurement approaches. This paper aims to critically discuss the exposure of Saudi banks to credit risk, assess their capital buffer in context of Basel III requirements, explore alternative methods for credit risk measurement, and evaluate the challenges posed by the COVID-19 pandemic to Saudi banks’ resilience.

Exposure of Saudi Banks to Credit Risk

Credit risk, defined as the potential loss arising from a borrower’s failure to meet contractual obligations, remains the primary risk faced by banks globally, including those in Saudi Arabia. Bajwa (2019) highlights that Saudi banks exhibit substantial exposure to credit risk, primarily because of their large loan portfolios across various sectors such as real estate, manufacturing, and consumer finance. The concentration of loans in specific sectors, especially real estate, heightens vulnerability to economic downturns or sector-specific shocks.

The oil-dependent Saudi economy is particularly susceptible to fluctuations in crude oil prices, which directly influence borrowers’ repayment capabilities. During periods of low oil prices, non-performing loans (NPLs) tend to increase, elevating credit risk. Bajwa notes that the aggressive expansion of credit in the years preceding the study period led to an elevated risk exposure. Additionally, the geographic concentration of banks’ lending activities within Saudi Arabia concentrates systemic risk, necessitating effective risk mitigation strategies to manage potential losses.

The regulatory environment, as examined by Bajwa, indicates that Saudi banks have adopted prudent lending standards; however, challenges remain. The high default rates in certain sectors reveal gaps in risk assessment techniques and the need for more robust credit appraisal mechanisms. Furthermore, the emergence of new financial products and digital lending channels introduces additional layers of credit risk, complicating the banks’ risk management processes.

Assessment of Saudi Banks’ Capital Adequacy in Relation to Basel III Requirements

Capital adequacy ratio (CAR) is a critical measure that ensures banks maintain sufficient capital to absorb potential losses and protect depositors and the financial system. Bajwa’s (2019) analysis shows that Saudi banks, on average, maintain capital levels above the minimum Basel III standards (which stipulate a CAR of at least 8% of risk-weighted assets).

The study reveals that Saudi banks have proactively increased their core capital buffers in anticipation of Basel III compliance, which emphasizes higher quality capital, primarily common equity. The Saudi Central Bank (SAMA) has implemented Basel III standards gradually, pushing banks to strengthen their capital positions. Bajwa observes that most banks in the sample exhibit a CAR ranging from 12% to 15%, visibly above the minimum requirement.

However, while the capital levels appear adequate, Bajwa cautions that the sufficiency of capital must be evaluated in the context of rising credit risks, especially given external shocks like oil price volatility and economic uncertainties. The recent decline in oil revenues impacts government spending and profitability of sectors critical to bank lending. Some banks might need to further bolster their capital to cushion potential future losses, aligning with Basel III’s emphasis on high-quality, loss-absorbing capital. Overall, Bajwa concludes that Saudi banks are currently well-capitalized but must remain vigilant and adaptable to ongoing global and domestic challenges.

Alternative Approaches to Measure Credit Risk

While financial ratio analysis provides valuable insights into a bank’s financial health and risk exposure, it may not fully capture the complexity and dynamic nature of credit risk. Bajwa’s study utilizes ratio analysis effectively; however, alternative methods could enhance the measurement and management of credit risk among Saudi banks.

One prominent approach is the use of Credit Scoring Models, particularly machine learning-based models, which provide real-time, predictive insights into borrower default risks. These models analyze large volumes of borrower data, including transactional history, credit behavior, and macroeconomic variables, to generate risk scores with higher accuracy and timeliness. Implementing such models would allow banks to identify emerging risks earlier, enabling proactive adjustments in lending strategies.

Another method is the Structural Credit Risk Models, such as the Merton Model, which estimate default probabilities based on the firm's asset value and debt structure. These models incorporate market data and firm-specific information, providing a quantitative estimate of default risk that complements traditional ratio analysis. Structural models can be particularly useful in evaluating complex loans or corporate exposures prevalent in Saudi banks’ portfolios.

Additionally, the Stress Testing and Scenario Analysis approaches simulate adverse macroeconomic scenarios, such as oil price shocks or pandemics, assessing the resilience of banks’ portfolios under stressed conditions. This method provides insights into potential vulnerabilities not apparent through historical ratios alone and informs strategic planning and capital adequacy assessments.

The reason for employing these alternative methods lies in their ability to provide forward-looking, granular, and dynamic risk assessments. They enhance the predictive accuracy and responsiveness of credit risk management, crucial for banks operating in volatile economic environments like Saudi Arabia’s. Combining traditional ratio analysis with advanced modeling techniques ensures a more comprehensive and resilient risk management framework.

Impact of COVID-19 Pandemic on Saudi Banks: Strengths and Weaknesses

The COVID-19 pandemic has posed unprecedented challenges globally, and the Saudi financial system is no exception. The pandemic’s liquidity shocks and economic slowdown threaten the stability of banks and the broader economy. Analyzing the strengths and weaknesses of Saudi banks provides insights into their capacity to withstand such crises.

Strengths:

Firstly, Saudi banks have demonstrated strong liquidity positions pre-pandemic. The high liquidity ratios and conservative asset-side management, along with robust deposit bases, provide a buffer against shocks. SAMA’s proactive policy measures, including liquidity injections and relaxations in regulatory requirements, have further bolstered banks’ resilience.

Secondly, the regulatory environment in Saudi Arabia is proactive and aligned with international standards. Post-2019 reforms have improved risk governance and stress testing capabilities, increasing the agility of banks to respond to crises. The common equity Tier 1 capital ratios have remained solid, enabling banks to absorb shocks without immediate systemic risk escalation.

Thirdly, digitization and technological investments have allowed banks to continue operations amid lockdowns. Digital channels facilitated loan restructuring, customer engagement, and transaction continuity, mitigating some adverse effects of COVID-related disruptions.

Weaknesses:

Despite these strengths, several vulnerabilities persist. The heavy reliance on oil revenues makes the Saudi economy susceptible to oil price fluctuations exacerbated during COVID-19, affecting government spending and corporate revenues. This, in turn, heightened credit risk exposure, especially in sectors most reliant on government contracts or oil services.

Secondly, small and regional banks may lack the diversification and risk management capacity of larger institutions, exposing them to higher default risks amidst economic downturns. Limited access to diversified funding sources and reliance on short-term deposits heighten liquidity risk during crises.

Thirdly, the pandemic has accelerated non-performing loan (NPL) ratios, especially among sectors like real estate, hospitality, and retail. While banks have provisioned for potential losses, the true extent of asset quality deterioration remains uncertain, challenging their capital adequacy and risk management frameworks.

Lastly, the overall economic slowdown and unemployment increase may lead to delayed repayments, further stressing banks’ financial stability. The ability of banks to support economic recovery depends on the effectiveness of government stimulus measures and internal risk mitigation strategies.

Conclusion

The COVID-19 pandemic has underscored the importance of resilient financial systems. Saudi banks, benefiting from strong liquidity and regulatory oversight, possess significant strengths. However, inherent vulnerabilities linked to economic dependence on oil revenues and limited diversification pose risks. Moving forward, strengthening risk assessment techniques, diversifying lending portfolios, and enhancing support mechanisms will be vital for Saudi banks to navigate ongoing and future challenges effectively.

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