Page 1 of 18

Journal for Studies in Management and Planning

Available at http://internationaljournalofresearch.org/index.php/JSMaP

e-ISSN: 2395-0463

Volume 01 Issue 05

June 2015

Available online: http://internationaljournalofresearch.org/ P a g e | 117

The Casual relationship model between Commercial

Banks’ Performance and Risk Management in Yemen:

Panel Evidence

Ebrahim Almekhlafi

1 Khalil Almekhlafi

2 Kargbo Mohamed3 Xiangpei Hu4

1School of Management, Dalian University of Technology, Dalian, 116023, China,

Email: ealmekhlafi@ymail.com

2 Faculty of Administrative Sciences, Al-bayda University, Yemen,

Email: khelcoo2004@gmail.com

3School of Finance and Economics, Dalian University of Technology, 116023, China,

Email: mohamedkay17@yahoo.com

4School of Management, Dalian University of Technology, Dalian, 116023, China,

Email: drhxp@dlut.edu.cn

Abstract:

Slow growth in the banking sector has been the

case in the Middle East and North Africa

(MENA) region in the 1970s and 1990s. This

situation was the case for Yemen, the banking

sector is dominated by public sector banks,

which are characterized by government

intervention in credit allocations, losses and

liquidity problems and wide interest rates

spread, poor asset quality, non-performing

loans, cash and overall liquidity constraints.

Given that poor banking sector performance

may have negative consequences on the

financial sector and hence economic growth.

We investigate empirically the determinants

of bank performance and its implication on

bank risk management in Yemen from 1998-

2013 using panel data evidence. The study

shows that non-performing loans negatively

affect profitability. Weak risk management

mechanisms, non-optimal interest rates

spread were also observed as factors that

affect the liquidity and general operations of

banks in Yemen and hence profitability. In

general all the six banks are profitable with

a very minimal average Return on Assets

(ROA) of 0.69% and average 29.2% volume

of non-performing loans. The hypotheses that,

prudent risk management improves banks

performance and that casualty exists between

bank performance and risk management are

supported as it is evidenced by the Pair wise- Correlation matrices and Granger Casualty test.

This study contributes to current literature by

providing an econometric understanding of

relationship in bank performance and bank risk

management for the MENA countries. This

understanding is important for academics,

policy makers and development organizations in

shaping the future banking and financial sector

infrastructure and hence economic growth.

Keywords: Bank Performance, Bank Risk

Management, Panel Evidence, Correlation,

Causality Test and Yemen.

Introduction

Albeit the Central Bank in its

implementation of monetary policy has a

sole responsibility of monitoring and

supervising the activities of Commercial

Banks in Yemen through both on-site and

off-site bank examination executed by the

Supervision Department adhering to the

statutory and prudential requirements such

as the Capital Adequacy, Management

Efficiency, Liquidity and Sensitivity to risk

(CAMELS) ratings of the Basel 1,2 & 3

according to Part III of the Banking Act

Page 2 of 18

Journal for Studies in Management and Planning

Available at http://internationaljournalofresearch.org/index.php/JSMaP

e-ISSN: 2395-0463

Volume 01 Issue 05

June 2015

Available online: http://internationaljournalofresearch.org/ P a g e | 118

2000, revised 2010, in order to eradicate and

mitigate banking system risk to a lower ebb.

The banking sector performance and its

implication on risk management practices is

a controversial topic fraught with difficulties

and challenges that ultimately results to poor

banking performance that incubate tendency

and leading to unfavourable banking

performance with unclear balance sheet,

bank failure and crisis in the financial sector

leading to a systemic risk and thus have a

negative functional ramification on

economic growth. This study does not

ignore banking system failure and it

consequences it may have on the financial

sector and the overall growth climate.

Recently, the world has witnessed one of the

most devastating financial meltdowns of

2007-2009, as a result of ineffective and

inefficient policy and procedures of

statutory prudential requirement. The most

affected sector was the financial services

industry, particularly the banking sector and

it became a regular target for tougher

regulation, public anger and academic

critics, and one factor that has received

considerable attention during the financial

crisis is risk management discourse.

However, studies on banks performance and

its implications on risk management in the

banking industry are rare; examples of some

of the studies in addition to the financial

turmoil of 2007-2009, was the economic

crisis of Vietnam and the banking and

financial crises in Asia largely on account of

Non-performing loans (NPL) with

inappropriate loan loss provisioning and

forced several banks in Indonesia and

Thailand to collapse and close operation.

(Ahmed and Ariff , 2007)

The performance of the banking sector can

be affected by internal and external factors

characterized by bank specific factors

(Management, Board and Ownership etc)

and macroeconomic factors (Inflation, Real

Interest Rate, Real Gross Domestic Product

etc). Banks play a pivotal role as

depositories and often provide the main

financial instrument for household wealth

and are the major financial intermediaries in

developing countries. (Gelb, 1989).This

implies that maintaining confidence in the

banking sector is important for avoiding a

disruption of the financial sector and hence

economic growth.

Much of the existing literature on banks

profitability and its implication on risk

management attribute greater importance to

the rate of physical capital accumulation in

the process of economic growth; the rate of

capital accumulation in the banking sector

depends upon the control of its quality,

quantity and efficiency of its risk

management. The advent of the financial

services modernization Act of 1998 was

embraced with a lot of excitement by banks

to diversify into broader range of services

and products making life really cool for

banking entrepreneurs and managers.

During periods of increased uncertainty

banking institutions may decide to diversify

their portfolio and/or raise their liquid

holdings in order to reduce risk. However,

this diversification advantage is once in a

life time opportunity that should be

consumed with some caution and prudency

as this may involve a great deal of risk,

therefore the very nature of banking

business is so sensitive because credit

creation process exposes banks to high

default risk and thereby affecting its

liquidity and general operation that might

lead to financial distress including

bankruptcy (Saunders and Cornett, 2005).

To this end, the need for risk management in

the banking sector is inherent in the nature

of banking business. Poor asset quality and

low levels & deficient liquidity position are

Page 3 of 18

Journal for Studies in Management and Planning

Available at http://internationaljournalofresearch.org/index.php/JSMaP

e-ISSN: 2395-0463

Volume 01 Issue 05

June 2015

Available online: http://internationaljournalofresearch.org/ P a g e | 119

the two major causes of bank failures.

However, in today’s dynamic environment,

banks are exposed to a large number of risk

such as credit risk, liquidity risk, operational

risk and macro economic instability,

(inflation, weak growth) among others are

the risks that creates some source of threat

for banks survival and success (Al-Tamimi,

Al-Mazrooei, 2007).

It is important to note that the instability of

the banking sector offer important

theoretical insights and policy

recommendation that are particularly

valuable in areas of the world suffering from

banking and financial crisis and low level of

domestic mobilization of capital for

investment and economic growth.

Consistent with this notion, on building a

safe, sound and stable banking system and

promote financial and economic growth in

the Middle East and North Africa (MENA)

region requires robust approach to building

the confidence and stability of the Banking

sector and hence economic growth. Slow

growth has been the case in the region since

the 1970s and 1980s. This worsened in the

1990s partly as a result of civil unrest and

political instability in the region which

adversely affected planning and growth.

(Central Bank of Yemen Annual Report, 2013)

The financial sector performance of most

MENA countries in the 1990s spanning to

early 2000s has been dismally limited, with

uneven reforms in the financial sector, the

banking sector is dominated by public sector

banks, which are characterized by

government intervention in credit

allocations, losses and liquidity problems

and wide interest rates spread. Given the

growing concern by MENA countries to

improve on the poor growth episodes and

financial sector restraints of the 1970s to

1990s, development of the financial sector

attracted considerable attention from policy

makers across the region with prudent

reforms in the sector by improving access to

finance for investment and extensive

liberalization of the financial sector in the

region, managing banking risk to its low ebb

(International Financial Institutions and

Yemen Country Report, 2007).

This scenario was the case for Yemen, the

growth performance of the country in the

last decades was weak, and classified as the

poorest country in the MENA region,

coupled with the range of successive crises

and growth challenges led to increase in

poverty and food insecurity. The financial

sector in Yemen is dominated by the banking

sector, as is the case for most developing

countries and is considered as one of the

weakest in the MENA region and as such

any failure in the sector has an immense

implication on the economic growth of the

country. This is due to the fact that any

unfavourable banking performance say

bankruptcy that could happen in the sector

has a contagion effect that incubate tendency

of banking systemic risk that can lead to

lack of confidence in the banking Industry,

bank runs, crises and economic turmoil.

(Financial Infrastructure Development Project of

Yemen, 2013)

The poor and unfavourable performance of

the economy is partly blamed to the

ineffective and inefficient functioning of the

banking system as demonstrated by the

untimely and inadequate bank supervision,

weak coordination among banks and the

subjective assessments of credit creation not

consistent across banks and leading to high

volume of non-performing loans and

liquidity problem and impacts negatively on

the banking industry. The sector was

significantly affected by the uncertainties of

the 2011 crisis leading to a fall in banking

balance sheet as large deposit withdrawals in

both local and foreign currencies were made