The Evolution of Saudi Arabia’s Financial System and Money Supply Endogeneity

Abstract

This thesis investigates the evolving nature of the money creation process in Saudi Arabia’s financial system over the period from 1930 to 2025. I build on alternative theories of money supply—beyond the traditional monetarist view and the money multiplier theory—and apply Victoria Chick’s stage theory of banking to the Kingdom’s financial developments. I demonstrate that institutional forces shaping Saudi Arabia's monetary-financial landscape have increasingly exhibited characteristics of a credit-led functional financial system. This suggests that the Kingdom’s money supply mechanism may have shifted from being exogenous to more endogenous in recent decades. To test this hypothesis, I utilize a monthly dataset of monetary and financial statistics from the Saudi Central Bank covering the period from 2000 to 2025 and employ advanced time-series analysis to examine the relationships between bank loans, money supply, and bank reserves. My findings reveal that: (1) The Saudi Central Bank’s reserve provision is the key mechanism in restoring long-run equilibrium among variables, indicating that the central bank accommodates banks’ reserve demand ex post; and (2) The directions of causation run from loans to money and from money to reserves, supporting the view that money and credit creation in Saudi Arabia is driven by financial activity, not by the central bank. Overall, this thesis suggests significant implications for policy authorities. Importantly, the traditional monetarist policy approach focusing solely on reserves would be ineffective in influencing private credit and money creation. Moreover, the recent expansion of private financial intermediaries, marked by the dominance of industrial bank lending and demand deposits, underscores the need to further develop coordinated industrial and banking policies to maintain the industrial functionality of Saudi Arabia’s financial system.