Monetary Policy and Bank Liquidity Creation: Empirical Evidence from Saudi Arabia

Abstract

This study examines the impact of both conventional and unconventional monetary policies of the US Federal Reserve (FED) and the Saudi Central Bank (SAMA) on liquidity creation in Saudi Arabia's banking sector. Using a sample of 12 banks from 2000 to 2023, a Generalized Least Squares (GLS) regression analysis was applied to assess the relationship between these policies and liquidity creation. The findings reveal that interest rates in both the US (IUS) and Saudi Arabia (ISA) negatively affect liquidity creation, while the expansion of central bank balance sheets (CBSUS and CBSSA) positively influences it. Profitability (ROA) and non-performing loans (NPL) negatively impact liquidity creation, with higher leverage boosting asset-side liquidity creation but reducing liquidity creation on the liability side. The study also suggests that Saudi banks respond to the FED's conventional policies and SAMA's unconventional policies but do not react similarly to FED unconventional policies or SAMA’s conventional ones. This reflects the influence of the US on Saudi monetary policy due to the fixed exchange rate between the Saudi riyal and the US dollar. However, these findings may have limited generalizability due to the study’s small sample size, positioning it as a case study for Saudi Arabia. The research highlights SAMA’s capacity to utilize unconventional tools to achieve its monetary goals while maintaining the fixed exchange rate regime. By linking monetary policies to liquidity creation, the study provides valuable insights for improving policymaking in Saudi Arabia, assisting SAMA in achieving its inflation and growth targets.