See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/339029044

The Interactional Relationships Between Credit Risk, Liquidity Risk

and Bank Profitability in MENA Region

Article  in  Global Business Review · February 2020

DOI: 10.1177/0972150919879304

CITATIONS READS
26 2,254

3 authors, including:

Abdelaziz Hakimi Helmi Hamdi

Faculty of Law, Economics and Management of Jendouba, University … Central Bank Bahrain
75 PUBLICATIONS   717 CITATIONS    87 PUBLICATIONS   1,957 CITATIONS   

SEE PROFILE SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Macroproduential policy and Financial Stability View project

Technical SCIENCE ⚙ View project

All content following this page was uploaded by Helmi Hamdi on 30 December 2020.

The user has requested enhancement of the downloaded file.

Original Article

The Interactional Relationships Global Business Review

1–23
Between Credit Risk, Liquidity © 2020 IMI
Reprints and permissions:
Risk and Bank Profitability in in.sagepub.com/journals-permissions-india
DOI: 10.1177/0972150919879304
MENA Region journals.sagepub.com/home/gbr

Hakimi Abdelaziz1
Boussaada Rim1
Hamdi Helmi2

Abstract
The purpose of this article is to investigate the relationship between credit risk, liquidity risks and bank
profitability within the Middle East and North African (MENA) countries. We selected data related
to a sample of conventional banks observed during the period 2004–2015 and we performed the
Seemingly Unrelated Regression (SUR) method in the empirical section. The overall results suggest
that profitability of MENA banks is negatively and significantly sensitive to an increase in credit and/
or liquidity risks. This negative effect was confirmed for either the separate or the interaction effects
of these two risks. Furthermore, the findings indicate that bank profitability decreases significantly the
level of credit and liquidity risks. We also found that the law and order as institutional quality increases
the profitability of MENA banks and decreases both credit and liquidity risks.

Keywords
Credit risk, liquidity risk, profitability, MENA banks, SUR method

Introduction
Following the international financial crisis of 2008, the liquidity risk has become one of the most
important issues for both policymakers and academics. As reaction to avoid the recurrence of such crisis,
policymakers have implemented several measures to reinforce capital and bank liquidity. These new
reforms are taking in order to keep the overall banking system sound and safe (Hamdi & Hakimi, 2019).
In both developing and developed economies, the bad quality of asset has been at the core of costly
banking crises (Nikolaidou & Vogiazas, 2017). Credit risk usually proxied by the level of nonperforming
loans (NPLs) was considered as the main determinant of bank failures that leads to banking crisis

1
Faculty of Law, Economics and Management of Jendouba, University of Jendouba and V.P.N.C lab FSJEG, Jendouba, Tunisia and
GEF2A lab, Université de Tunis, Tunis, Tunisia.
2
Aix-Marseille University, CERGAM, EA 4225, France.

Corresponding author:
Hakimi Abdelaziz, Faculty of Law, Economics and Management of Jendouba, University of Jendouba and V.P.N.C lab FSJEG,
Jendouba, Tunisia.
E-mail: abdelazizhakimi@yahoo.fr
2 Global Business Review

(Reinhart & Rogoff, 2011). Banks that experienced a high level of NPLs may threaten the stability of the
banking industry and the whole financial system. More generally, banks often face or take distinct risks,
such as credit and/or liquidity risks. Despite that each of these risks may exist independently, they are
often dependent and reciprocal in reality. Liquidity is considered as a fundamental part of banking
operations (Cornett et al., 2011), and credits are one of the main assets generating profit for the bank
(Greuning & Bratanovic, 2004).
According to the modern theory of financial intermediation (Bhattacharya & Thakor 1993), banks exist
because they ensure two crucial roles. First, they are considered as liquidity provider and second they
transform risk. Classic theories of the financial intermediation support the view that liquidity and credit
risks are closely linked. However, several studies have looked into bank credit or liquidity risks separately
(Chen et al., 2018; Hakimi & Zaghdoudi, 2017; Hamdi & Hakimi, 2019; Partovi & Matousek, 2019).
There is a little research effort devoted to investigate the relationship between credit risk, liquidity
risk and bank profitability in MENA region (Ghenimi, Chaibi, & Omri, 2017). Most empirical studies
are focussed on the American context (De Nicolo, 2000; Imbierowicz & Rauch, 2014), the European
context (Chortareas, Girardone, & Ventouri, 2011; Kim, 2015; Thorsten, Heiko, Thomas, & Natalja,
2009) and Asian countries (Arif & Anees, 2012; Sohaimi, 2013; Tan, 2016; Zolkifli, Abdul Hamid, &
Hawati Janor, 2015). The collapse of the global financial system, following the late-2000 crisis, has
raised concern that bank risk-taking has negatively affected the financial stability in various countries.
For this reason, the policy agenda for financial sector reforms in developing regions requires, among
other issues, an accurate analysis of the impact of bank risk-taking, in order to take into account, the
specific features and peculiarities of regions and to identify the proper policy measures to be implemented.
This article aims to investigate the relationship between credit risk, liquidity risks and bank profitability
within the Middle East and North African (MENA) countries. To this end, we used data from 38
conventional banks located in 10 MENA countries and observed during the period of 2004–2015. Taking
into the reciprocal relationship between credit and liquidity risks and considering these two risks as the
main factors that affect bank profitability, our empirical approach is based on simultaneous equations.
More precisely, we use the Seemingly Unrelated Regression (SUR) method of Zellner (1962). Empirical
results of the SUR method indicate that bank profitability is negatively and significantly sensitive to an
increase in credit and liquidity risks. Furthermore, the findings indicate that bank profitability decreases
significantly the level of credit and liquidity risks. We also found that the law and order as institutional
quality increases the profitability of MENA banks and decreases both credit and liquidity risks. As
surprising results, we have found that capital adequacy ratio is negatively and significantly correlated
with the bank profitability and significantly increases the liquidity risk.
This article extends the existing literature by focussing on the MENA region, where the banking
sector is a crucial driver for economic development and growth. In some MENA countries, the economic
stability depends on the stability of their banking system. For example, bank assets account for 60 per
cent to over 100 per cent of gross domestic product (GDP) across MENA countries (Ghosh, 2017). On
the other hand, banking system is still characterized by the dominance of state-owned banks, high level
of NPLs and weak level of liquidity. For all these reasons, we grant more attention to study the factors
that affect bank profitability, pillar that affect the stability of the whole banking system through which
economic stability may be affected. This study differs from previous studies and contributes to the
existing literature in several ways. Frist, the MENA region is considered as an appropriate case of study
as the banking sector is considered as the main source of financing the economy. Hence, it is of great
importance for policymakers to focus on how ensuring profitability and stability of this banking sector.
Second, unlike earlier studies that investigated either the impact of credit or liquidity risks on bank
profitability, in the current study, we tested the interaction of these two risks on the bank profitability.
Abdelaziz et al. 3

Third, we introduce in our econometric model institutional variables to capture the bank risk–profitability
relationship. Finally, most of studies focussed on the impact of bank risks on bank profitability have used
ordinary least square (OLS), fixed and random effect and/or dynamic panel data analysis. In this article,
we performed a simultaneous equation, based on the SUR.
The rest of this article is structured as follows. Section 2 gives literature review on the reciprocal
relation between credit and liquidity risks and their effects on bank profitability. Section 3 describes
briefly the MENA banking sector. While, section 4 presents and discusses the empirical analysis. In
section 5, we conclude.

Review of Literature
We start this section by reviewing the reciprocal relationship between credit and liquidity risks, then we
present recent development on the relationships between credit risk and bank profitability and finally, we
summarize studies on the effect of liquidity risk on bank profitability.

The Reciprocal Relationship Between Credit and Liquidity Risks

Theoretically, credit risk is related to liquidity risk through borrower defaults and fund withdrawals
(Diamond & Dybvig, 1983). Banks’ mix of illiquid (long maturity) assets and liquid (short-term)
liabilities may lead to panic among depositors which may be displayed through borrower defaults and
fund withdrawals. Banks’ asset and liability structures are closely connected, especially in terms of
borrower defaults and deposit outflows (Bryant, 1980). Banks, mostly because of their maturity
transformation role, are exposed to the liquidity risk. A loan default can increase liquidity risk by leading
to a decrease in cash flow and depreciations in loan assets (Dermine, 1986; Diamond and Rajan, 2001).
Thus, according to the classical financial intermediation theory, a relationship exists between credit and
liquidity risks. Moreover, when banks have a high level of liquidity, their managers tend to take more
risk by lowering the lending standards for the intention of increasing the volume of loans (Acharya &
Naqvi, 2012).
Generally speaking, literature on the relationship between credit and liquidity risks has revealed two
main views. The first view is articulated around the financial intermediation theory. Several studies have
concluded that credit risks are positively related in banks. They stated that the financing of risky or
distressed project leads to an increase in NPLs that decreases bank liquidity and struggle banks to meet
depositors’ demands for funds (Acharya & Viswanathan, 2011; Gorton & Metrick, 2011; He & Xiong,
2012). For the Ukrainian context, Cai and Zhang (2017) over the period from Q1 2009 to Q4 2015 have
reported that with high level of non-performing loans, banks are unable to respond partial or integral
withdrawal demands. This situation lowers cash flow and triggers depreciations in loan assets and leads
to an increase liquidity risk. Cai and Zhang (2017) have found that for foreign and large banks, the
positive association between credit and liquidity risks is more pronounced. Using a sample of banks in
43 countries over the period of 2002–2010, Chen and Lin (2016) show that credit, interest rate and
liquidity risks are related to one another, and that the interactions among them can be reduced by
corporate governance and regulations.
The second view supports the opposite view. Less abundant empirical studies document a negative
relation or no relation between liquidity and credit risks (Cai & Thakor, 2008; Wagner, 2007). For
example, Imbierowicz and Rauch (2014) investigate US commercial banks during the period of 1998–
4 Global Business Review

2010 and analyze the relationship between these the credit and liquidity risks sources on the bank
institutional level, and how this relationship influences banks’ probabilities of default. They show that
the two risks do not have an economically meaningful reciprocal contemporaneous or time-lagged
relationship. However, they do influence banks’ probability of default.

Credit Risk and Bank Profitability

Literature on the effect of credit risk and bank profitability provides mixed and inconclusive results. Some
empirical studies have supported the negative association (Athanasoglou et al. (2008); Berríos, 2013;
Cucinelli, 2015; Laryea, tow-Gyamfi, & Azumah Alu, 2016). However, few studies found positive
evidence (Flamini, Valentina, McDonald, & Liliana, 2009; Hakimi, Hamdi, & Djelassi, 2011).
In banking literature, several measures have been used as proxy of credit risk. However, the standard and
the most used indicator is the NPLs ratio. Broadly, a loan is classified as non-performing when payments
of principal and interest are 90 days or more past due. An increase in bad loans in turn increases the non-
payments of credits, which lower the profitability of MENA banks and could even lead to bank failure.
Most of the studies focussed on the determinants of bank profitability have used bank specifics,
industry specifics, institutional quality, macroeconomic and financial environment to explain changes in
bank profitability. Some others have carried out on the effect of non-traditional activities based on the
non-interest incomes. In this line of idea, Isshaq et al. (2019) used a bank-level financial statement
related to the Ghanaian economy over the period of 1999–2015 to explore the link between NII, risk and
performance. The authors found that NII increases profitability for large banks. However, no significant
effect of non-interest income (NII) on bank risk was found. Sufian (2009) has analyzed the determinants
of bank profitability in the Malaysian context over the period of 2000–2004. The main findings of this
study indicate that credit risk and loan concentration decrease significantly the level of profitability.
However, well-capitalized banks with more banking activities diversification registered higher
profitability level.
Some recent studies have reported that credit risk could be influenced by corporate governance. For
example, to investigate the link between internal governance mechanism and credit risk, Ben Moussa
(2019) used a sample of listed banks observed during the 2000–2014 period. The empirical results show
that the higher board size and the duality are associated with lower quality of credit that increases credit
risk. However, the author found that the presence of independent and foreign investors enhances credit
quality and hence decreases the level of NPLs.
Using a sample of 488 Italian banks over the period of 2007–2013, Cucinelli (2015) found that credit
risk exerts a negative impact on bank lending behaviour. In this study, NPLs and loan loss provision ratio
are used as measures of credit risk. Similarly, Athanasoglou et al. (2008) have used a sample of a panel
of Greek banks over the period of 1985–2001 and reported that credit risk decreases significantly the
bank profitability. The authors explained this result by the risk-averse strategy adopted by Greek banks
in order to maximize their profits. Berríos (2013) has used a sample of 40 banks observed during the
period of 2005–2009 to analyze the linkage between credit risk and profitability and liquidity. Empirical
findings show a negative association between less prudent lending and net interest margin.
Abu Hanifa, Pervin, Chowdhury, and Banna, (2015) investigated the effect of credit risk on profitability
in Bangladesh. To this end, they used a sample of 18 banks over the period of 2003–2013. Empirical
results indicate that credit risk decreases significantly the bank profitability. Focussing on an emerging
market, Laryea et al. (2016) have used a sample of 22 Ghanaian banks over the period of 2005–2010 to
investigate the effect of NPLs on bank profitability. The empirical results confirm the negative relationship.
Abdelaziz et al. 5

However, there are less abundant studies that support the positive relationship between bank
profitability and credit risk. This positive association is due to the measure of credit risk. Some studies
that used loan to assets as proxy of credit risk, generally have found positive relation. An increase in the
loan to assets’ ratio leads to an increase in bank profitability. Banks with high loan to assets received
more interest revenue that increases the interest margin and consequently the bank profitability. For
example, for the Sub-Saharan African context, Flamini et al. (2009) have used a sample of 389 banks in
41 Sub-Saharan African countries over the period of 1998–2006. The authors found a positive relation
between credit risk and bank profitability. In this study, credit risk was measured by asset quality based
on standard asset pricing. The same result was found by Hakimi et al. (2011) for the Tunisian context
basis on a sample of nine banks over the period of 1980–2009. Based on this development above, we can
put the following hypothesis:

H1: Credit risk decreases the level of bank profitability.

Liquidity Risk and Bank Profitability

Literature on the effect of liquidity risk and bank profitability is ambiguous. In fact, some empirical
studies reported that liquidity affects positively bank profitability (Bourke, 1989; Kosmidou, Tanna, &
Pasiouras, 2005; Olagunju, David, & Samuel, 2012), while many others concluded that liquidity exerts
a negative effect on bank profitability under the misallocation of resources.
The negative effect of liquidity risk was confirmed by several studies. For example, the study of
Cuong Ly (2015) focussed on the effect of liquidity risk on the profitability of European banks during
the period of 2001–2011 indicates that liquidity risk decreases significantly the bank profitability.
However, for the same European context, Cucinelli (2015) has found that there is no significant
association between liquidity and probability of default in the long term. Based on a sample of 97 banks
from G7 and the Switzerland, Mamatzakis and Bermpei (2014) have reported that liquidity exerts a
negative impact on bank profitability. More recently, Adelopo, Lloydking, and Tauringana (2018) have
used a sample of 123 banks over the period of 1999–2013. Empirical findings indicate that liquidity risk
decreases significantly the bank profitability during the three sub-periods of study.
The same negative association between liquidity risk and bank profitability was confirmed for the
Iranian example, which was investigated by Tabari, Ahmadi, and Emami (2013) for a sample of Iranian
commercial banks over the period of 2003–2010. The authors reported that both credit and liquidity risks
exert a negative and significative effect on the profitability of Iranian banks. Within the same Asian
context, Arif and Anees (2012) have used a sample of 22 Pakistani banks during the period of 2004–2009
to check the relationship between liquidity risk and bank profitability. They found that there is a negative
and significant association between liquidity risk and bank profitability. Furthermore, results indicate
that the liquidity gap and the level of NPLs are the main factors that increased liquidity risk.
The effect of liquidity risk on bank profitability was recently explored by Hamdi and Hakimi (2019).
The authors found that this relation is nonlinear and the effect of liquidity risk on bank profitability
depends on a certain optimal threshold. The used a large sample of 127 countries observed during the
period of 2005–2015. The whole sample was divided into 46 high-income countries and 81 low- and
middle-income countries. Results of the panel smooth transition regression (PSTR) model indicate that
the optimal level of liquidity and its effect on bank profitability differ from one group of countries to
another. The Tunisian context was explored by Hakimi and Zaghdoudi (2017). The authors have used a
sample of 10 Tunisian banks for the period of 1990–2013. The results of random effect regression show
6 Global Business Review

that liquidity risk decreases significantly Tunisian bank profitability. For the South African context,
Marozva (2015) has used a sample of banks over the period of 1998–2014. Bank profitability was
measured by the net interest margin. Empirical findings of the autoregressive distributed lag (ARDL)-
bound approach show that liquidity risk negatively affects bank profitability. With reference to the
findings of these studies, we formulate the following hypothesis:

H2: Liquidity risk exerts a negative effect on bank profitability.

Since credit and liquidity risks are qualified as reciprocal risks, and based on the two hypotheses
formulated above that supposed the negative effect of both credit and liquidity risks on bank profitability,
we can propose the following third hypothesis:

H3: The interaction between credit and liquidity risks decreases bank profitability.

Banking Sector in the MENA Region

The MENA region contains both ends of the spectrum; it ranges from the wealthiest and biggest oil-
producing countries to the politically unstable and oil-importing countries. During the past two decades,
some countries in the MENA region have recorded continuous strong economic growth, while some
others have been stuck in political conflict and civil war that inhibit their growth.
In general, banking system in the MENA region presents not only some similarities but also some
differences. For example, in the North African countries, banking sector is dominated by state-owned
banks, and it plays a crucial role in the economy as it is recognized as the principal source of funding.
According to Ghosh (2017), bank assets account for 60 per cent to over 100 per cent of GDP across
MENA countries. Compared the North African countries, banking sector in the Gulf Cooperation Council
(GCC) region is more developed, more stable and less exposed to bank risks. Furthermore, banking
sector in the Middle East in general is more profitable and more efficient while North Africa’s banking
sector recorded low profitability, insufficient liquidity and high level of NPLs.
Table 1 presents the average annual evolution of some indicators related to banking system in MENA
region. For example, we analyze the annual evolution of profitability measured by the ROA and the
ROE. Also, we analyze the evolution of bank risks in this region, more precisely the credit and the
liquidity risks. Data used in this table are collected from the Global Financial Development Database.

Table 1. Annual Evolution of Profitability and Bank Risks in the MENA Region
Bank Profitability (%) Bank Risks (%)
Years ROA ROE LIQR CRISK
2004 1.58 14.29 87.30 16.44
2005 1.99 15.69 90.60 13.76
2006 1.78 14.54 93.36 9.23
2007 1.71 15.22 92.52 7.94
2008 1.42 12.92 97.48 5.46
2009 1.26 12.03 98.33 10.16
2010 1.46 12.41 91.72 8.25
(Table 1 Continued)
Abdelaziz et al. 7

(Table 1 Continued)
Bank Profitability (%) Bank Risks (%)
Years ROA ROE LIQR CRISK
2011 1.23 10.61 89.98 6.12
2012 1.52 12.73 90.19 5.92
2013 1.58 12.90 88.07 6.00
2014 1.51 13.14 86.00 5.58
2015 1.43 12.55 87.09 5.46
Source: The authors.

From Table 1, it was shown that the profitability of MENA banks has followed a downward trend
during the period of 2004–2015. The ratio of ROA was 1.58 per cent in 2004 and became 1.43 per cent
in 2015. The same trend was registered by the ROE which crossed from 14.29 per cent in 2004 to reach
only 12.55 per cent.
Regarding the evolution of the credit risk, Table 1 indicates that the level of NPLs in the MENA region
has significantly decreased moving from 16.44 in percentage of total loans to be only 5.46 per cent in
2015. This downturn was explained by the several actions and steps that have been taken to respect
international Basel standard in terms of increasing capital adequacy ratio and reducing NPLs.
As measured by the ratio of loans to deposits, an increase in this ratio means that banks are more
exposed to liquidity risk. However, any decrease in this ratio indicates on a sufficient level of liquidity.
Contrary to the downward trend registered for the credit risk, the MENA banks have recorded an increase
in the liquidity risk. The ratio of loans to deposits crossed from 87.30 per cent in 2004 to reach 97.48 per
cent in 2008 and 98.33 per cent in 2009. This increase was explained by the decrease in the level of
deposit during the period of the international financial crisis of 2008. During the period of 2010–2015,
the level of liquidity risk returned to record a downward trend with a ratio of 87.09 per cent in 2015.

Theoretical Framework

Methodology—Data Source, Sample Frame and Empirical Model

To investigate the effect of credit risk, liquidity risk and their interaction with bank profitability, we
used an initial sample made by 112 banks. However, due to the availability and the continuity of
bank’s information, several banks have been excluded. For example, we exclude Islamic banks,
investment banks and non-commercial banks to ensure the homogeneity of the sample. Hence, only
65 banks have been retained. Moreover, we eliminate 27 commercial banks for which data on NPLs
were missing. The final sample was then reduced to only 38 conventional banks located in 10 MENA
countries1 over the period of 2004–2015. Bank-level data are obtained from the Bankscope database
and the annual reports of each bank. However, macroeconomic conditions are collected from World
Bank Indicators (WDI) database.
Since credit and liquidity risks are considered as reciprocal risks and also recognized as the main
determinants of bank profitability, our empirical approach is based on simultaneous equations. More
precisely, we use the SUR method of Zellner (1962). The SUR model is system of multiple equations
(M) with single dependent variable for each equation and (K) independent or exogenous variables. In
econometrics literature, observed variables are considered either endogenous (dependent) or exogenous
(independent) variables.
8 Global Business Review

For these M equations, there is no relationship between them except that their disturbances are
correlated. Based on the previous studies (Felmlee & Hargens, 1988; Kim & Cho, 2019; Kmenta, 1971;
Zellner, 1962, 1963), the general specification of SUR simultaneous equation systems can be represented
as follows:

Y1 = β11 + β12 X12 + β13 X13 + …………… + β1K X1K1 + ε1(1)

Y2 = β21 + β22 X12 + β23 X23 + …………… + β2K X2K2 + ε2(2)

YM = βM1 + βM2 X12 + βM3 XM3 + ……… + βMK XMKM + εM(3)

or
Ym = X m b m + e m ( m = 1, 2    m)


where Ym is an (N × 1) vector of dependent variable, Xm is an (N × K) of independent variables (with Xmi

= 1 for all m), βm is a (Km 1) vector of coefficient regressions and εm is an (N × 1) vector of disturbances.
The use of SUR method was firstly motivated by the gain efficiency in estimation, since it results
information combination from different equations. Second, using this method, it will be able to test
restrictions that involve parameters in different equations. Compared with OLS estimators, the two-stage
general least square (GLS) and ML estimators of SUR model are considered as most efficient. These two
methods provide smaller standard errors especially for large sample. However, with reference to
Hanushek and Jackson (1977) dealing with small sample and having covariances of disturbances for the
multiples equations equal to zero, the OLS estimators are the best linear unbiased estimates. Taking into
consideration, the advantage of this estimator and since the sample used in this study is made by only 38
banks; we performed the OLS estimators of the SUR method.
The empirical analysis of this study is based on three steps. The first step consists to test separately
the effect of credit and liquidity risks on bank profitability. In Equation (1), bank profitability (PROF) is
the dependent variable. In Equation (2), credit risk (CRISK) is the dependent variable. Liquidity risk
(LIQR) is the endogenous variable in Equation (3). The SUR model can be written as follows:

PROF = β10 + β11 CRISK11 + β12 LIQR 12 +β13 SIZE 13 +

β14CAP 14 +β15 CRISIS15+ β16GDP 16 +β17 INF 17 + ε1 (1)

CRISK= β20 + β21 PROF21+ β22 LIQR22 + β23 SIZE 23+

β24 CAP24 + β25 CRISIS25+ β26 GDP26 +β27 INF27 + ε2  (2)

LIQR = β30 + β31 PROF31 + β32 CRISK32+

β33 SIZE33+ β34CAP 34 + β35 CRISIS35 + β36GDP36 + β37 INF 37 + ε3 (3)

In the second step, the effect of the interaction between credit and liquidity risks on the bank profitability
measured by the ROA and the ROE. In Equation (4), PROF is the dependent variable. In Equation (5),
the interaction between the two risks (CRISK × LIQR) is considered as the endogenous variable. Hence,
the SUR model can be written as follows:
Abdelaziz et al. 9

PROFi,t = β10 + β11 CRISK x LIQR11+ β12 SIZE12 +

β13CAP13 + β14 CRISIS14+ β15GDP15 + β16 INF16 + ε1(4)

CRISK x LIQR i,t = β20 + β21 PROF21 + β22 SIZE 12 +

β23CAP 23 + β24 CRISIS24+ β25 GDP25 + β26 INF26 + ε1(5)

Besides bank specifics and macroeconomic conditions, we believe that institutional quality could play a
crucial role in the bank risk–profitability relationship. Hence, we investigate in a third step whether
institutional quality enhances regulatory mechanisms and improves bank profitability or not. Therefore,
we estimate Equations (1)–(3) by introducing two institutional variables: the government stability
(GOVS) and the law and order of law (LAW). To the best of our knowledge, no article has studied yet
the interaction between credit and liquidity risks on bank profitability using institutional quality data.
The empirical model can be written as follows:
n n n
Dependvar = b10 + ∑bX
i =1
i i,t + ∑ b i Yi,t ∑ b i Z i,t + e i (6)
i =1 i =1

where dependent variables are profitability, credit and liquidity risks, X is the matrix of bank-specific
variables (PROF, CRISK, LIQR, SIZE and CAP), Y is the matrix of financial environment and
macroeconomic variables (international financial crisis, inflation and GDP growth) and Z is the matrix
of institutional variables (government stability and law and order).
Table 2 gives the definition and measurement of all variables used in this study. We classified variables
into three categories: dependent variables, bank-specific variables and variables that reflected
macroeconomics conditions and institutional context.

Table 2. Definition and Measurement of Variables

Variables Definition Measurement
Dependent variables
PROF Bank profitability Return on assets (ROA) and return on equity (ROE)
CRISK Credit risk Bank NPLs to gross loans (%)
LQIR Liquidity risk Loans to deposit ratio (%)
CRISK ×
LIQR Interaction term The interaction between credit and liquidity risks
Bank specifics
SIZE Bank size Napierian logarithm of total assets
CAP Capital adequacy ratio Bank capital to total assets (%)
Macroeconomic conditions
Growth of gross
GDPG domestic product Economic growth measured by annual growth rate of GDP (%)
INF Inflation rate Inflation rate measured by consumer price index (%)
Institutional quality
Government stability: score of the International Country Risk Guide
(ICRG) that ranges between 0 (weak government stability) and 12
GOVS (strong government stability).
Law and order: score of the ICRG that ranges between 0 (weak strong
LAW law and order) and 5 (strong law and order).
Source: The authors.
10 Global Business Review

Table 3. Descriptive Statistics

Variable Obs. Mean Std. Dev. Min. Max.

ROA 452 0.037 0.199 -0.103 2.090
ROE 452 0.129 0.120 -1.119 0.797
CRISK 451 0.091 0.086 0.002 0.479
LIQR 441 0.716 0.269 0.047 1.456
CRISK × LIQR 456 0.064 0.079 0.000 0.500
SIZE 456 16.123 1.822 11.581 20.105
CAP 456 0.112 0.040 -0.016 0.256
LAW 456 4.535 0.582 2.875 5.000
GOVS 456 9.001 1.868 5.208 11.500
CRISIS 456 0.667 0.472 0 1
GDPG 456 0.049 0.039 -0.019 0.208
INF 428 0.043 0.037 -0.049 0.183
Source: The authors.

Analysis

Descriptive Statistics and Correlation Matrix

Table 3 presents information about descriptive statistics of all the variables used in the empirical model.
These statistics give more details about characteristics of banking sector and macroeconomic specifics
in the MENA region. Descriptive statistics are displayed in Table 3.
From Table 3, we notice that the mean value of bank profitability for the selected banks in MENA
region is 3.7 per cent for ROA and 12.8 per cent for ROE. These two indicators register a maximum
value of 209 per cent for ROA and 79.7 per cent for ROE, while their minimum values are –10.3 per cent
for ROA and –111.9 per cent for ROE, respectively.
With regard to bank size, banks in the MENA region record on average a value of 16.123. The
minimum and the maximum sizes are 11.581 and 20.105, respectively. From Table 3, we also notice that
on average banks in MENA region are moderately capitalized with a value of 11.2 per cent. However, it
does not prevent the existence of some others less capitalized with a minimum value of –1.6 per cent and
well capitalized with a maximum value of 25.6 per cent. In this study, NPLs are used as proxy of credit
risk. MENA banks record on average a value of 9.1 per cent. However, the maximum value of NPLs to
total loans represents 47.9 per cent. As reciprocal risk, the mean value of liquidity risk is 71.6 per cent
with a maximum of 145.6 per cent and a minimum of 4.7 per cent.
For institutional quality, statistics indicate that the average value of law and order is 4.535, while its
maximum value is 5. For the mean value of government stability, Table 3 reveals 9.001 as the mean value
and 11.5 as the maximum value.
Since banks operate in a macroeconomic environment, we introduce two variables in our empirical
model: the real GDP growth and the inflation rate. The highest level of growth recoded by MENA region
during the period of 2004–2015 was 20.8 per cent, while the weakest level was –1.9 per cent. Descriptive
statistics also indicate that during the same period, the mean value of inflation was 4.3 per cent with 18.3
per cent as maximum value and –4.9 per cent as minimum value.
Abdelaziz et al. 11

Table 4. Correlation Matrix

CRISK ×
CRISK LIQR LIQR SIZE CAP LAW GOVS CRISIS GDPG INF
CRISK 1.0000
LIQR 0.0985 1.0000
CRISK ×
LIQR 0.8569 0.4488 1.0000
SIZE -0.4203 0.0286 -0.3097 1.0000
CAP -0.1835 0.1227 -0.1493 -0.1314 1.0000
LAW 0.0116 0.5134 0.2227 0.0562 -0.0036 1.0000
Govs -0.2186 0.2869 -0.0629 0.2186 0.2711 0.3581 1.0000
CRISIS -0.1975 0.0353 -0.0950 0.2093 0.0511 0.1204 0.5631 1.0000
GDPG -0.1839 0.0181 -0.1612 0.0718 0.2699 0.0377 -0.0983 -0.2863 1.0000
INF -0.0153 -0.1607 -0.0884 -0.0252 0.0719 -0.3866 -0.1351 -0.0186 0.1680 1.0000
Source: The authors.

Table 4 presents the levels of correlation between independent variables. To this end, we have
used the Pearson correlation to check the nature (positive or negative) and the level (high or weak)
of correlation.
From Table 4, we conclude that the level of correlation between all independent variables is very
weak. The highest level of correlation is between CRISK and the interaction between credit and liquidity
risks (CRISK × LIQR). Since the second variable is an interaction variable, we expected a high level of
correlation between the two variables. To avoid multicollinearity problem, these two variables are not
introduced jointly in the same econometric model. As independent variables, the interaction variable
(CRISK × LIQR) was tested only in model (4). Thus, we can conclude that there is no significant
problem of multicollinearity.

Discussion

The Separate Effect of Credit and Liquidity Risks on Bank Profitability

The use of the SUR method requires the disturbances correlation as necessary condition. It is for this
reason that we firstly check the residuals correlation of three equations that should be different to zero.
Table 5 gives the results of correlation matrix of residuals and Breusch–Pagan test of independence.
From Table 5, we notice that, for the correlation of the residuals in the PROF, CRISK and LIQR
equations are different from zero that we can reject the hypothesis that this correlation is zero. Therefore,
the residuals of the three equations are correlated. Also, the result of the test of Breusch–Pagan indicates
that there is a residual correlation. The probabilities of this test are equal to 0.0013 when profitability is
measured by ROA and 0.000 for ROE which are lower than 5 per cent and confirm the correlation
between residuals of the three equations.
12 Global Business Review

Table 5. Correlation Matrix of Residuals

Prof is Measured by ROA Prof is Measured by ROE

Prof Crisk Liqr Prof Crisk Liqr
PROF 1.0000 1.0000
CRISK 0.1042 1.0000 0.4246 1.0000
LIQR 0.0602 -0.1546 1.0000 0.0933 -0.1064 1.0000
Breusch–Pagan test of independence
χ2(2) 15.697 81.922
Prob. (0.0013) (0.0000)
Source: The authors.

Once, we have checked and confirmed the disturbances correlation of the three equations, we can
apply the SUR method. Table 6 summarizes the results of the separate effect of credit and liquidity risks
on bank profitability in the MENA region.
With regards to Equation (1), we have found that credit risk; liquidity risk and bank size decreases
significantly the bank profitability for both ROA and ROE. As surprising result, findings also indicate
that capital adequacy ratio is negatively and significantly correlated with the bank profitability only for
ROE. For the macroeconomic effect, results show that only the inflation exerts a positive and significant
effect on ROE; however, the GDP growth do not exert any significant effect.
Measured by the NPLs, credit risk is shown to be negatively and significantly correlated with bank
profitability for both ROA and ROE. As we expect this association, an increase in bad loans increases the
non-payments of credits, which lower the profitability of MENA banks and could even lead to bank
failure. Also, when borrowers are unable to fulfil their commitments, banks become more rigid, stickier
and more restrictive towards credit distribution, which lower interest revenues and consequently banking
profitability. This result is in line with Hamdi, Rachdi, Hakimi, and Guesmi (2018).
As reciprocal risk and similarly to the effect of credit risk, liquidity risk decreases significantly the
bank profitability measured by ROA and ROE. In banking literature, liquidity was recognized as the
necessary pillar of banking activity. It was considered as the main input to support bank profitability.
Less-liquid banks tend to have lower profitability. Under the traditional bank activities, banks as financial
intermediaries operate based on liquidity. Furthermore, insufficient liquidity is one of the factors that
negatively affect income revenues derived from loans’ activity which lower bank profitability and reduce
bank reputation, customer trust. This result corroborates the findings of Kosmidou (2008), Marozva
(2015) and Hakimi and Zaghdoudi (2017).
From Table 6, we notice that an increase in bank size decreases significantly the level of bank
profitability. This result is confirmed for both ROA and ROE. Despite that large banks have the advantage
of economies of scale that leads to lower costs; we found that bank size is negatively and significantly
correlated with bank profitability. Big banks can be engaged in more diversified activities and be faced
to high level of conflict of interest, governance problems and asymmetric information with higher cost
of information. In such a case, it results bad loans’ decisions that lead to an increase in NPLs, which
negatively impacts bank profitability. This finding is convergent to the study of Barros, Ferreira, and
Willians (2007) and divergent to Pasiouras & Kosmidou (2007); Berger Hanweck, & Humphrey (1987).
Abdelaziz et al. 13

Table 6. Results of Separate Effect on Bank Profitability: SUR Model

Profitability is ROA Profitability is ROE

Equations Coef. Z Coef. Z
Profitability CRISK -0.557 -3.970*** -1.041 -17.050***
(Equation [1]) Liqr -0.083 -2.080*** -0.050 -2.710***
SIZE -0.023 -3.590*** -0.001 -0.440
CAP -0.424 -1.490 -0.277 -2.080**
CRISIS -0.020 -0.790 -0.050 -4.160***
GDPG 0.278 0.930 -0.177 -1.250
INF 0.195 0.670 0.442 3.250***
_cons 0.556 4.700*** 0.330 6.040
Credit risk PROF -0.068 -3.970*** -0.474 -17.050***
(Equation [2]) LIQR 0.083 6.080*** 0.041 3.290***
SIZE -0.019 -9.210*** -0.010 -5.130***
CAP -0.443 -4.570*** -0.361 -4.080***
CRISIS 0.027 3.010*** 0.037 4.550***
GDPG -0.309 -2.980*** -0.257 -1.530***
INF 0.161 1.600 0.310 3.360***
_cons 0.412 11.380*** 0.341 10.400***
Liquidity
risk PROF -0.127 -2.08*** -0.348 -2.710***
(Equation [3]) CRISK 1.044 6.08*** 0.625 3.290***
SIZE 0.021 2.68*** 0.021 2.720***
CAP 0.960 2.74*** 0.865 2.480**
CRISIS 0.011 0.36 -0.007 -0.210
GDPG 0.463 1.24 0.323 0.870
INF -1.206 -3.41*** -1.062 -2.970***
_cons 0.213 1.44 0.310 2.120**
Equations Obs. RMSE R2 χ2 p-Value Obs. RMSE R2 χ2 p-Value
Profitability 409 0.2059 0.0283 33.1400 0.0000 409 0.101 0.207 376.390 0.000
Credit risk 409 0.0725 0.2508 194.5400 0.0000 409 0.068 0.334 489.990 0.000
Liquidity risk 409 0.2569 0.0404 59.3400 0.0000 409 0.254 0.060 46.510 0.000
Source: The authors.
Note: *** and ** indicate level of significance at 1% and 5%, respectively.

The most surprising for these results is the negative and significant association between capital
adequacy ratio and the return on equity. Theoretically, it was admitted that a better-capitalized bank should
14 Global Business Review

be more profitable. However, in this study, we have found that CAP exerts a negative and significant effect
on bank profitability for both ROA and ROE. We can explain this surprising result as following: in some
cases, an increase in capital leads to an increase in bank risk-taking. High-capitalized banks can extend
credit with insufficient guarantees, which increases the level of NPLs and lower bank profitability. This
finding is similar to Aggarwal and Jacques (1998) and contradicts the works of Abreu & Mendes (2002);
Goddard et al. (2010); Garcia-Herrero et al. (2009).
With regard to the effect of the international financial crisis of 2008 (CRISIS), the results show a
negative and significant association between this variable and bank profitability measured by ROE.
These results show that MENA banking sector was not sheltered from the subprime crisis, especially
when we remember the crisis that hit Dubai in 2009 where most local and foreign banks have recorded
colossal losses. Our results are in line with most of the researches that studied the impact of the 2008
crisis on bank profitability (Hamdi et al., 2018).
The results of Equation (2) indicate that bank profitability, bank size, capital adequacy ratio and GDP
growth are negatively and significantly correlated with credit risk. However, the results show that only
liquidity risk, financial crisis and inflation increase significantly the level of NPLs.
Table 6 reveals that an increase in bank profitability decreases significantly the level of credit risk
measured by NPLs. Recording satisfactory level of profitability, banks can be engaged in an improvement
process of credit risk management. Banks are motivated by enhancing their experiences and their skills
in the process of credit risk management in order to cover this risk and to reduce the probability that will
be exposed to this risk. With high level of profitability, banks are able to spend and to finance the
improvement of credit risk management process.
The level of growth proxied by GDP growth is found negatively and significantly correlated with
credit risk. An increase in the level of growth in the MENA region decreases significantly the level of
NPLs in this region. Macroeconomic conditions allow for controlling for business cycle fluctuations.
Under a stable and favour economic condition, the probability of solvency increases and borrowers are
able to fulfil their commitments. Hence, the banking profitability increases. This result is in line with the
works of Athanasoglou et al. (2008) and Calza, Gartner, and Sousa (2003).
Empirical findings also indicate that only liquidity risk, crisis and inflation increase significantly the
level of NPLs. Considered as reciprocal risk, an increase in liquidity risk leads to an increase in credit risk.
In the period of crisis, the level of NPLs has witnessed a sudden increase. Several studies show that
NPLs are one of the crucial determinants of banking and financial crises and hence, during the turmoil,
the level of NPLs gets worse, which in turn adds more vulnerability and risk.
The results of Equation (3) show that an increase in the level of banks profitability decreases
significantly the level of liquidity risk. However, it was also found that liquidity risk increases when
credit risk, bank size and capital ratio increase.
The more profitable banks are the less exposed to liquidity risk. Recording a certain level of
profitability, banks become more capitalized and try to reinforce their own equity in order to improve
customer reputation and to lower the exposition to liquidity risk. We also find that the inflation rate acts
negatively and significantly on the liquidity risk. Economically, inflation leads to a redistribution of
income in favour of borrowers than of lenders. It is for this reason that banks become more rigid and
restrict their lending activities in inflationary context.
Giving the reciprocal relationship between credit and liquidity risks, the results indicate that an
increase in credit risk leads to the drying up of bank liquidity and the increase in liquidity risk. The high
level of NPLs causes losses of principal and interest, which decreases banking liquidity, and more
exposes banks in MENA region to a problem of insufficient liquidity.
Abdelaziz et al. 15

The results of SUR model show that the capital adequacy ratio (CAP) is positively and significantly
correlated with liquidity risk. This result seems surprising since the most capitalized banks are normally
less exposed to liquidity risk. However, in the context of high competition, weak prudential regulation
and inefficient governance practices, banks can adopt risk-taking behaviour with granting credits
sometimes without sufficient guarantees, which will be finished in some case by bad loans with high
level of NPLs. The high level of credit risk leads to an increase in the liquidity risk.

The Interaction Effect of Credit Risk, Liquidity Risk on Bank Profitability

Like the first step, we start our empirical analysis by checking the disturbances correlation. The results
displayed in Table 7 indicate that the correlation of the two equations is different from zero, which
confirms the correlation among residuals.
From Table 7, we also conclude that the probability of χ2 of the Breusch–Pagan test of independence
is lower than 5 per cent that we can reject the hypothesis that residuals are independent. This test confirms
once again that the residuals of the two equations are correlated between them.
In the second step, we aim to test the interaction effect of credit and liquidity risks (CRISK ´ LIQR)
on the MENA bank profitability. The empirical results are displayed in Table 8.

Table 7. Correlation Matrix of Residuals

Prof is Measured by ROA Prof is Measured by ROE

PROF CRISK × LIQR PROF CRISK × LIQR
PROF 1.0000 1.0000
CRISK × LIQR 0.1101 1.0000 0.4421 1.0000
Breusch–Pagan test of independence
χ2 (1) 5.139 82.871
Prob. (0.0234) (0.0000)
Source: The authors.

Table 8. Results of the Interaction Effect (CRISK × LIQR) on Bank Profitability

Profitability is ROA Profitability is ROE

Coef. Z Coef. Z
CRISK ×
Profitability LIQR -0.631 -4.530*** -1.226 -18.560***
(Equation [4]) SIZE -0.022 -3.700*** 0.002 0.530
CAP -0.498 -1.810* -0.437 -3.100***
CRISIS -0.011 -0.440 -0.053 -4.270***
GDPG 0.330 1.130 -0.128 -0.850
INF 0.159 0.590 0.306 2.190**
_cons 0.475 4.360*** 0.261 4.710***
(Table 8 Continued)
16 Global Business Review

(Table 8 Continued)
Profitability is ROA Profitability is ROE
Coef. Z Coef. Z
CRISK ×
LIQR PROF -0.075 -4.530*** -0.446 -18.560***
(Equation [5]) SIZE -0.014 -7.400*** -0.005 -2.970***
CAP -0.411 -4.420*** -0.372 -4.450***
CRISIS 0.014 1.720* 0.030 4.000***
GDPG -0.170 -1.540 -0.149 -1.560
INF -0.113 -1.210 0.077 0.910
_cons 0.371 10.960*** 0.276 9.020***
Equations Obs. RMSE R2 χ2 p-Value Obs. RMSE R2 χ2 p-Value
Profitability 424 0.203 0.023 30.430 0.000 424 0.110 0.199 405.170 0.000
Crisk × Liqr 424 0.070 0.171 109.070 0.000 424 0.066 0.260 453.330 0.000
Source: The authors.
Note: *** and ** indicate level of significance at 1% and 5%, respectively.

The results displayed in Table 8 indicate that the bank profitability is negatively sensitive to the
interaction between the two risks. The results indicate that the interaction between credit and liquidity
risks is negatively and significantly at 1 per cent level with bank profitability measured by ROA and
ROE. Nevertheless, it was shown that an increase in bank profitability decreases jointly credit and
liquidity risks.

The Role of Institutional Quality in the Bank Risk–Profitability Relationship

In the third step, we test whether institutional quality strengths or threats bank profitability through an
indirect effect on credit and liquidity risks. Theoretically, it was confirmed that good institutional
quality leads to an improvement of regulatory enforcement and reinforce the lending terms that
positively affects the probability of loan repayment and decreases the liquidity risk (Akins et al., 2017;
Francis et al., 2014).
Table 9 presents the results of correlation matrix of residuals and Breusch–Pagan test of independence.

Table 9. Correlation of Disturbances:

PROF is Measured by ROA PROF is Measured by ROE

PROF CRISK LIQR PROF CRISK LIQR
PROF 1.0000 1.0000
CRISK 0.1073 1.0000 0.4335 1.0000
LIQR 0.1102 -0.1638 1.0000 0.0172 -0.1454 1.0000
Breusch–Pagan test of independence
(Table 9 Continued)
Abdelaziz et al. 17

(Table 9 Continued)
PROF is Measured by ROA PROF is Measured by ROE
PROF CRISK LIQR PROF CRISK LIQR
χ2(2) 15.690 85.538
Prob. (0.0013) (0.0000)
Source: The authors.

Table 9 indicates that the probability of χ2 of the Breusch–Pagan test of independence is lower than 5
per cent that we can reject the hypothesis that residuals are independent. Once again, it confirms that the
residuals of the three equations are correlated between them.
The results of the third step that consist to test the direct effect of institutional quality on credit and
liquidity risks and the indirect effect on bank profitability are given in Table 10.
As for the effect of institutional quality, the results in Table 10 indicate that the coefficient of law and
order is positive and significant at 1 per cent level for both ROA and ROE. However, the effect of
government stability is found to be only significant at 10 per cent when the ROE is the dependent
variable. This means that with higher levels of the law and judicial efficiency, it results an improvement
of regulatory enforcement that improves bank-lending activity through the protection of creditors rights
that increase bank profitability and ensure the stability of the whole banking system. Our results are
similar to the work of Daher (2017) and Olken (2007).
The findings indicate also that the law and order decreases significantly the level of credit and liquidity
risks. Coefficient of this variable is negative and significant at 1 per cent level. Under a strong and strict
law and order, it results high probability of loan repayment due to strong creditor rights and the rule of
law. Also, the high level of judicial efficiency improves the lending terms necessary condition to reduce
borrower moral hazard and decrease loan defaults. When the probability of loans repayment increases,
the level of credit and liquidity risks decreases. Our findings are in line with and Bushman et al. (2004).

Conclusion
The lack of studies that combine the effect of credit risk, liquidity risk and the interaction effect between
each other has motivated us to investigate this topic within the MENA region context. Since credit and
liquidity risks are considered as reciprocal risks and recognized as the main determinants of bank
profitability, our empirical approach is based on simultaneous equation. More precisely, we use the SUR
method of Zellner (1962) and we use a sample of 38 conventional banks observed during the period of
2004–2015. The empirical analysis of this study is based on two steps. The first step consists of testing
separately the effect of credit and liquidity risks on bank profitability measured by the ROA and the
ROE, and the second step studies the effect of the interaction between both risks on bank profitability.
The empirical results indicate that the profitability of the MENA banks is negatively and significantly
sensitive to an increase in credit and liquidity risks. This negative effect is confirmed either when we test
separately the impact of these two risks in Equations (2) and (3) or jointly in Equation (4). Qualified as
reciprocal risks, an increase in credit risk leads to the increase in liquidity risk for MENA banks and vice
versa. Furthermore, we have found that bank profitability decreases significantly the level of credit and
liquidity risks. Also, this negative effect is confirmed for either the separate or the interaction effects of
these two risks.
Table 10. Results of the Effects of Institutional Quality 18
Profitability is
ROA Profitability is ROE
Equations Variables Coef. z Coef. z
Profitability CRISK -0.571 -4.100*** -1.051 -17.640***
(Equation [1]) LIQR -0.031 -0.680 0.016 0.780
SIZE -0.024 -3.750*** -0.002 -0.820
CAP -0.649 -2.170*** -0.482 -3.480***
LAW 0.063 2.670*** 0.047 4.280***
GOVS 0.009 1.750* 0.009 2.360**
CRISIS -0.034 -1.140 -0.064 -4.600***
GDPG 0.423 1.690* 0.072 0.510
INF -0.034 -0.110 0.317 2.260**
_cons 0.783 5.200*** 0.471 6.840***
Credit risk Prof -0.070 -4.100*** -0.495 -17.640***
(Equation [2]) LIQR 0.093 5.980*** 0.076 5.360***
SIZE -0.019 -9.040*** -0.010 -5.020***
CAP -0.448 -4.330*** -0.460 -4.900***
RLAW -0.009 -2.110** -0.036 -4.670***
GOVS -0.001 -1.740* 0.003 1.030
CRISIS 0.023 2.180** 0.039 4.130***
GDPG 0.286 2.710*** -0.170 -1.380
INF 0.115 1.090 0.182 1.490
_cons 0.456 9.380*** 0.470 10.770***
Liquidity risk PROF 0.018 0.330 0.090 0.780
(Equation [3]) CRISK 0.982 6.590*** 0.886 5.360***
SIZE 0.018 2.650*** 0.015 2.180**
CAP 1.163 3.600*** 1.130 3.490***
Global Business Review

LAW -0.230 -9.870*** -0.234 -9.890***

(Table 10 Continued)
 Abdelaziz et al.

(Table 10 Continued)
Profitability is
ROA Profitability is ROE
GOVS 0.014 1.620 0.013 1.500
CRISIS -0.035 -1.060 -0.034 -1.020
GDPG -0.189 -0.570 -0.238 -0.720
INF 0.103 0.310 0.089 0.270
_cons -0.941 -5.770*** -0.893 -5.480***
Equations Obs. RMSE R2 χ2 p-Value Obs. RMSE R2 χ2 p-Value
Profitability 409 0.204 0.044 41.220 0.000 409 0.099 0.243 403.610 0.000
Credit risk 409 0.072 0.254 197.640 0.000 409 0.068 0.333 525.220 0.000
Liquidity risk 409 0.257 0.041 59.070 0.000 409 0.222 0.283 189.080 0.000
Source: The authors.
Note: *** and ** indicate level of significance at 1% and 5%, respectively
19
20 Global Business Review

By introducing institutional quality variables, we also found that the law and order increases the
profitability of MENA banks and decreases both credit and liquidity risks. Surprisingly, we have found
that capital adequacy is negatively and significantly correlated with the MENA bank profitability.
However, it significantly increases the liquidity risk. This implies more attention to the bank capital
allocation in this region.

Implications
The results of this article have some important policy implications for MENA banks. Banks in this region
should continue to reinforce the capital adequacy ratio but with more attention on how it will be allocated.
There is a strong need to further improve banking supervision, governance practices, credit decision-
making and credit risk management. Also, MENA banks are requested to improve their profitability
since it reduces both credit and liquidity risks. Since it was confirmed for MENA banks that credit and
liquidity risks are strongly reciprocal, we recommend to MENA banks to improve their loans quality and
to develop the process of credit risk management in order to reduce the level of NPLs and consequently
the level of liquidity risk.

Limitations/Future Research
This study has some limitations. First, the sample used in this study is based only on 38 banks and seems
very small to generalize findings. Second, to measure liquidity risk, we have only used loans to deposit
ratio (%) and we have not applied for the liquidity coverage ratio (LCR) and the net stable funding ration
(NSFR). Third, this current study was limited only to conventional banks.
The empirical findings of this article can be improved by taking into all these limitations. Hence,
using a large sample of MENA banks, introducing some Islamic banks and making comparison and
using others proxies of liquidity risk certainly improved the results of this article.

Acknowledgements
The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve
the quality of the article. Usual disclaimers apply.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of
this article.

Funding
The authors disclosed receipt of the following financial support for the research, authorship, and/or publication of
this article: This research did not receive any specific grant from funding agencies in the public, commercial or not-
for-profit sectors.

Note
1. Tunisia, Morocco, Egypt, Lebanon, Jordan, Qatar, Oman, Bahrain, United Arab Emirates and Saudi Arabia.
Abdelaziz et al. 21

ORCID iD
Hakimi Abdelaziz https://orcid.org/0000-0003-2715-0239

References
Abreu, M., and Mendes, V. (2002). Commercial bank interest margins and profitability: Evidence from E.U.
countries (University of Porto Working Paper no. 245). Porto: University of Porto.
Abu Hanifa, M-N., Pervin, P., Chowdhury, M-M., & Banna, H. (2015). The effect of credit risk on the banking
profitability: A case on Bangladesh. Global Journal of Management and Business Research: C Finance, 15(3), 1–9.
Acharya, V., & Naqvi, H. (2012). The seeds of a crisis: A theory of bank liquidity and risk taking over the business
cycle. Journal of Financial Economics, 106(2), 349–366.
Acharya V. & Viswanathan S. (2011). Leverage, moral hazard, and liquidity. Journal of Finance, 66(1), 99–138.
Adelopo, I., Lloydking, R., & Tauringana, V. (2018). Determinants of bank profitability before, during, and after the
financial crisis. International Journal of Managerial Finance, 14(4), 378–398.
Aggarwal, R., & Jacques, K. T. (1998). Assessing the impact of prompt corrective action on bank capital and risk.
Economic Policy Review, 4(3), 23–32.
Akins, B., Dou, Y., & Ng, J. (2017). Corruption in bank lending: The role of timely loan loss recognition. Journal of
Accounting and Economics, 63, 454–487.
Arif, A., & Anees, A. N. (2012). Liquidity risk and performance of banking system. Journal of Financial Regulation
and Compliance, 20(2), 182–195. Retrieved from https://doi.org/10.1108/13581981211218342
Athanasoglou, P., Brissimis, S., & Delis, M. (2008). Bank-specific industry-specific and macroeconomic
determinants of bank profitability. Journal of International Financial Markets. Institutions and Money, 18(2),
121–136.
Barros, C. P., Ferreira, C., & Willians, J. (2007). Analysing the determinants of performance of best and worst
European banks: A mixed logit approach. Journal of Banking and Finance, 31, 2189–2203.
Ben Moussa, F. (2019). The influence of internal corporate governance on bank credit risk: An empirical analysis
for Tunisia. Global Business Review, 20(3), 640–667.
Berger, A. N., Hanweck, G., & Humphrey, D. (1987). Competitive viability in banking: Scale, scope and product
mix economies. Journal of Monetary Economics, 20, 501–520.
Berríos, M-R. (2013). The relationship between bank credit risk and profitability and liquidity. The International
Journal of Business and Finance Research, 7(3), 105–118.
Bhattacharya, S., & Thakor, A. (1993). Contemporary banking theory, Journal of Financial Intermediation, 3, 2–50.
Bourke, P. (1989). Concentration and other determinants of bank profitability in Europe. North America and
Australia. Journal of Banking and Finance, 13, 65–79. Retrieved from https://doi.
org/10.1016/0378-4266(89)90020-4
Bryant J. (1980). A model of reserves, bank runs, and deposit insurance. Journal of Banking & Finance, 4(4),
335–344.
Bushman, R., Chen, Q., Engel, E., & Smith, A., (2004). Financial accounting information, organizational complexity
and corporate governance systems. Journal of Accounting and Economics, 37, 167–201.
Cai J., & Thakor A. (2008). Liquidity Risk, Credit Risk and Interbank Competition (SSRN Working Paper).
Cai, R., & Zhang, M. (2017). How does credit risk influence liquidity risk? Evidence from Ukrainian banks. Visnyk
of the National Bank of Ukraine, 241, 21–33.
Calza, A., Gartner, C., & Sousa, J. (2003). Modelling the demand for loans to the private sector in the euro area.
Applied Economics, 35, 107–117.
Chen, Y. K., Shen, C. H., Kao, L., & Yeh, C. Y. 2018. Bank Liquidity Risk and Performance. Review of Pacific Basin
Financial Markets and Policies, 21, 1–40.
Chen, H. J., & Lin, K. T. (2016). How Do Banks Make the Trade-Offs Among Risks? The Role of Corporate
Governance. Journal of Banking & Finance, 72, 39–69.
Chortareas, G., Girardone, C., & Ventouri, A. (2011). Bank supervision, regulation, and efficiency: Evidence from
the European Union. Journal of Financial Stability, 8(4), 292–302.
22 Global Business Review

Cornett, M.M., McNutt J.J., Strahan P.E. & Tehranian H. (2011). Liquidity risk management and credit supply in the
financial crisis. Journal of Financial Economics, 101, 297–312.
Cucinelli, D. (2015). The impact of non-performing loans on bank lending behavior: Evidence from the Italian
banking sector. Eurasian Journal of Business and Economics, 8(16), 59–71.
Cuong, Ly. K. (2015). Liquidity risk, regulation and bank performance: Evidence from European banks. Global
Economy and Finance Journal, 8(1), 11–33.
Daher, M. (2017). Creditor control rights, capital structure, and legal enforcement. Journal of Corporate Finance,
44, 308–330.
Dermine J. (1986). Deposit rates, credit rates and bank capital: The Klein-Monti Model Revisited. Journal of
Banking & Finance, 10(1), 99–114.
De Nicolo, G. (2000). Size, charter value and risk in banking: An international perspective. International Finance
Discussion N° 689, Board of Governors of the Federal Reserve System.
Diamond, D. W., & Dybvig, P. H. (1983). Bank Runs, Liquidity and Deposit Insurance. Journal of Political Economy,
91(3), 401–419.
Diamond D., & Rajan R. (2001). Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking.
Journal of Political Economy, 109(2), 287–327.
Felmlee, D., & Hargens, L. (1988). Estimation and hypothesis testing for seemingly unrelated faris and felmlee 71
regressions: A sociological application. Social Science Research, 17, 384–399.
Flamini, C., Valentina C., McDonald, G., & Liliana, S. (2009). The determinants of commercial bank profitability in
sub-saharan Africa (IMF Working Paper). Washington, DC: IMF.
Francis, B. B., Hasan, I., & Zhu, Y. (2014). Political uncertainty and bank loan contracting. Journal of Empirical
Finance, 29, 281–286
García-Herrero, A., Gavila´, S., & Santaba´rbara, D. (2009). What explains the low profitability of Chinese banks?
Journal of Banking and Finance, 33, 2080–2092.
Ghenimi, A.; Chaibi, H., & Omri, M. A. (2017). The effects of liquidity risk and credit risk on bank stability:
Evidence from the MENA region. Borsa Istanbul Review, 17(4), 238–248.
Ghosh, S. (2017). Corporate governance reforms and bank performance: Evidence from the Middle East and North
Africa. Corporate Governance, 17(5), 822–844.
Goddard, J., Liu, H., Molyneux, P., & Wilson, J. (2010). Do bank profits converge? European Financial Management,
19(2), 345–365.
Gorton, G., & Metrick A. (2011). Securitized Banking and the Run on Repo. Journal of Financial Economics,
104(3), 425–451
Greuning, H.V., & Bratanovic S.B. (2004). Analysing and Managing Banking Risk: A Framework for Assessing
Corporate Governance and Financial Risk (2nd ed.). Washington, DC: The World Bank.
Hakimi, A., Hamdi, H., & Djelassi, M. (2011). Financial liberalization and banking profitability: A panel data
analysis for Tunisian banks. International Journal of Economics and Financial Issue, 1(2), 19–32.
Hakimi, A., & Zaghdoudi, K. (2017). Liquidity risk and bank performance: An empirical test for Tunisian banks.
Business and Economic Research, 7(1), 46–57.
Hamdi, H., & Hakimi, A. (2019). Does liquidity matter on bank profitability? Evidence from a nonlinear framework
for a large sample. Business and Economics Research Journal, 10(1), 13–26.
Hamdi, H., Rachdi, H., Hakimi, A., & Guesmi, K. (2018). What drives banking profitability after the international
financial crisis of 2008? Evidence from Eurozone banks. Bankers, Markets & Investors, 152–153, 21–33.
Hanushek, E. A., & Jackson, J-E. (1977). Statistical methods for social scientists. New York, NY: Academic Press.
He Z., & Xiong W. (2012). Dynamic Debt Runs. Review of Financial Studies, 25(6), 1799–1843.
Imbierowicz, B., & Rauch, C. (2014). The relationship between liquidity risk and credit risk in banks. Journal of
Banking & Finance, 40, 242–256.
Isshaq, Z., Amoah, B., & Appiah-Gyamerah, I. (2019). Non-interest income, risk and bank performance. Global
Business Review, 20(3), 595–612.
Kim, C. (2015). Liquidity risk regulation and bank performance. Evidence from European bank. Global Economy
and Finance Journal, 8(1), 11–33.
 Abdelaziz et al. 23

Kim, J., & Cho, H. (2019). Seemingly unrelated regression tree. Journal of Applied Statistics, 46(7), 1177–1195.
Kmenta, J. (1971). Elements of econometrics. New York, NY: Macmillan.
Kosmidou, K. (2008). The determinants of banks’ profits in Greece during the period of EU financial integration.
Journal of Managerial Finance, 34(3), 146–159.
Kosmidou, K., Tanna, S., & Pasiouras, F. (2005). Determinants of profitability of domestic UK commercial banks: Panel
evidence from the period 1995–2002. In Proceedings of the 37th Annual Conference of the Money Macro and
Finance (MMF) Research Group, Rethymno, Greece, September.
Laryea, E., tow-Gyamfi, M., & Azumah Alu, A. (2016). Nonperforming loans and bank profitability: Evidence from
an emerging market. African Journal of Economic and Management Studies, 7(4), 1–37.
Mamatzakis, E., & Bermpei, T. (2014). What drives investment bank performance? The role of risk, liquidity and
fees prior to and during the crisis. International Review of Financial Analysis, 35, 102–117.
Marozva, G. (2015). Liquidity and bank performance. International Business & Economics Research Journal,
14(3), 453–462.
Nikolaidou, E., & Vogiazas, S. (2017). Credit risk determinants in sub-saharan banking systems: Evidence from five
countries and lessons learnt from Central East and South East European countries. Review of Development
Finance, 7, 52–63.
Olagunju, A., David, A. O., & Samuel, O. (2012). Liquidity management and commercial banks’ profitability in
Nigeria. Research Journal of Finance and Accounting, 2(7–8), 24–38.
Olken, B. (2007). Monitoring Corruption: Evidence from a Field Experiment in Indonesia. Journal of Political
Economy, 115, 200–249.
Partovi, E., & Matousek, R. (2019). Bank efficiency and non-performing loans: Evidence from Turkey. Research in
International Business and Finance, 48, 287–309.
Pasiouras, F., & Kosmidou, K. (2007). Factors influencing the profitability of domestic and foreign commercial
banks in the European Union. Research in International Business and Finance, 21(2), 222–237.
Reinhart, C M., & Rogoff, K. S. (2011). From Financial Crash to Debt Crisis. American Economic Review, 101(5),
1676–706.
Sohaimi, A. N. A. (2013). Liquidity risk and performance system in Malaysia (SSRN Working Paper).
Sufian, F. (2009). Factors influencing bank profitability in a developing economy: Empirical evidence from
Malaysia. Global Business Review, 10(2), 225–241.
Tabari, N., Ahmadi, A., & Emami, A. (2013). The effect of liquidity risk on the performance of commercial Banks.
International Research Journal of Applied and Basic Sciences, 4(6), 1624–1631.
Tan, Y. (2016). The impacts of risk and competition on bank profitability in China. Journal of International Financial
Markets, Institutions and Money, 40, 85–110.
Thorsten, B., Heiko, H., Thomas, K., & Natalja, V. (2009). Bank ownership and stability: Evidence from Germany
(IMF Working Paper 09/200). Washington, DC: IMF.
Wagner, W. (2007). Aggregate liquidity shortages, idiosyncratic liquidity smoothing and banking regulation. Journal
of Financial Stability, 3, 18–32.
Zellner, A. (1962). An efficient method of estimating seemingly unrelated regression equations and tests of
aggregation bias. Journal of the American Statistical Association, 57, 500–509.
———. (1963). Estimators for seemingly unrelated regression equations: Some finite sample results. Journal of the
American Statistical Association, 58, 977–992.
Zolkifli, N-A., Abdul Hamid, M., & Hawati Janor, H. (2015). Liquidity risk and performance: The case of Bahrain
and Malaysian banks. Global Economy and Finance Journal, 8(2), 95–111.

View publication stats