As financial intermediaries, banks accept deposits, which supply the cash needed to fund loans. The smooth operation of both supply of funds, and demand for funds, is fundamental to intermediation, as there must be sufficient deposits to create loans and creditworthy borrowers for these loans. Such was the normal conduct of banking, both in developed countries and developing countries. In the MENA (Middle East and North Africa) region, banks financed trade by making loans to exporters. The deposit base (particularly in the Gulf Cooperation Council (GCC) countries, which are a subset of the MENA region) was robust, with businesses making regular deposits and oil exporters making large deposits.
The outbreak of the highly infectious disease, COVID-19, in 2020 ushered in a black swan event. To protect against transmission of the disease, schools, businesses, and retail stores closed, resulting in the cessation of face-to-face business activity, widespread unemployment, and stay-at-home work. Aggregate demand, production, and foreign trade declined sharply (Ghosh and Saima 2021
). As financial intermediaries that convert deposits to loans, banks experienced both supply shocks and demand shocks. Supply shocks originated from deposit drains, as businesses and individuals withdrew savings to meet short-term liquidity needs. Businesses lost revenue from site closures and from revenue deferrals by business customers who had lost customers due to closures. Businesses needed bank deposits to pay fixed expenses, such as rent and utilities, that were paid from regular revenue in the pre-pandemic era. Individuals withdrew savings to supplement incomes diminished by unemployment. Such deposit drains reduced the number of loans that banks could issue. Prior to COVID-19, the MENA region was characterized by large volumes of nonperforming loans (Mdaghri 2022
) documented the loss of confidence by depositors in banks with high levels of nonperforming loans. This trend was exacerbated by the pandemic. Business borrowers, unable to collect trade credit from customers, defaulted, as did individuals who lost income from unemployment. Banks experienced losses in interest income and losses in loan principal from loan defaults. Demand for loans from creditworthy borrowers declined sharply, ushering in a demand shock. These outcomes occurred across the Middle East and North Africa (MENA) region (El-Chaarani et al. 2022
However, banks in the GCC (Gulf Cooperation Council) component of the MENA region may have coped with the COVID-19 crisis more effectively. The GCC consists of Bahrain, Kuwait, Qatar, Oman, United Arab Emirates, and Saudi Arabia. It is unique in that it consists of oil exporters with large cash reserves. Intuitively, a proportion of these cash reserves form the core deposits of large banks. Further, oil exporters may supply equity capital to banks, thereby becoming large shareholders. Therefore, the liquidity needed for bank deposits could have been maintained during the COVID-19 lockdown, thereby partly mitigating the supply shock to bank liquidity. However, the demand shock to banks of borrower defaults may have been unchanged.
Bank stability has been associated with good corporate governance. Corporate governance is practiced by board members who view themselves as stewards of the firm (Donaldson and Davis 1991
). It consists of board action to enhance the firm’s wealth. Measures include (1) a large board, which encourages a diversity of viewpoints, (2) independent directors on the board, who objectively evaluate management, (3) ownership by large shareholders, institutions, and foreigners, who reduce agency conflicts, (4) compensation-based performance, (5) ownership’s political concentration (large shareholders with relationships with politicians), and (6) managerial political connections. Fu et al.
) observed that effective corporate governance increases bank profits, reduces risk, creates value, and promotes efficient operations. It follows that some or all of these corporate governance variables may reduce the harmful effects of supply shocks or demand shocks on bank profitability during a financial crisis, such as the COVID-19 lockdown.
Institutional variables that influence bank performance include bank size and liquidity. Large shareholders gravitate to large banks. Given that large banks are symbols of economic stability, they are likely to receive government bailouts during crises, ensuring their access to loanable funds. Large banks also have access to business leaders, international organizations, and foreign depositors, all of which may provide deposits. The large volume of such deposits increases the total number of loans that may be created or increases bank liquidity.
In this paper, we explore the effects of certain corporate governance variables, and institutional variables on bank profits, measured as return on assets and return on equity. We expect that these variables will reduce the adverse effects on banks of supply shocks and demand shocks. They include the corporate governance variables of the ownership’s political concentration, managerial political connections, and independent directors. Large shareholders may have political connections with powerful individuals in government, such as ministers, who provide access to government sources of funding, and loan creation from large-scale infrastructure projects. Thus, large shareholders may maintain liquidity, even during crises, reducing the negative effects of supply shocks. The coalition hypothesis views large shareholders and politicians as forming a coalition that safeguards the interest of banks (Boussada and Hakimi 2021
). The presence of independent directors on the boards of directors of banks may result in objective evaluations of top management’s ability to reduce nonperforming loans. Such a reduction of defaults partly mitigates the demand shock of a financial crisis. Managerial political connections, or managerial relationships, may adversely affect bank profits, as managers may hire underperforming friends of politicians or invest in low-NPV projects supported by politicians. In order to examine both types of shock on bank performance, we measured the effects of the ownership’s political concentration, bank size, liquidity creation, managerial political connections, and independent directors on banks in GCC countries during the 2020–2021 COVID-19 lockdown. We envision the ownership’s political concentration, bank size, and liquidity creation as antidotes to supply shocks of fewer loans, while independent directors, and lack of managerial political connections, cope with demand shocks through efficient cost containment of issuing new financial products.
We advance knowledge in four key areas. The first area is banking in the MENA region. The literature on bank performance in the MENA region is fragmented, with studies on liquidity creation, bank size, and nonperforming loans. Key studies were performed by Mohammed
) and Boussada and Hakimi
) examined liquidity creation in banks in 18 MENA countries, finding that large banks created more liquidity than small banks and SME banks. Liquidity creation had a positive impact on the return on assets for large banks and an adverse effect on the return on assets for their small and medium-sized counterparts. Boussada and Hakimi
) obtained mixed results, with support for the dispersion hypothesis, whereby multiple large shareholders reduced profitability, and for the coalition hypothesis, with a few large shareholders increasing profitability. Other studies, such as Mdaghri
) and Sahyouni and Wang
), underscored the reduction in profitability from nonperforming loans due to the loss of confidence on the part of depositors with high nonperforming loans. They cautioned against excessive liquidity creation, which increased the percentage of nonperforming loans, with unchanged credit restrictions. To achieve coherence in the assessment of bank performance, our variables are lodged in a corporate governance framework. This framework employs board characteristics, such as independent directors, ownership concentration, and managerial governance characteristics, such as managerial political connections. Corporate governance is particularly important for banks during crises, as the financial crisis of 2007–2008 demonstrated that banks with strong governance structures provided protection for depositors (Khediri et al. 2021
) and built public trust (El-Chaarani and Abraham 2022
). Governance structures were particularly effective in curbing the extraction of private benefits from banks by politicians (Eichler and Sobański 2016
; La Porta et al. 2002
). We conjecture that the differential financial performance of different GCC banks may have been due to differential governance structures.
Although contributing to the literature on the MENA region, this paper views the GCC as a distinct entity within the MENA region. The MENA region consists of the GCC countries and economies that trade agricultural commodities with former colonial powers. The GCC has oil wealth, which bestows higher incomes upon its citizens. The rest of the MENA region has lower incomes from non-oil commodity trade. In other words, the oil wealth and higher incomes of GCC countries set them apart from the remainder of the MENA region. With undeveloped capital markets throughout the region, banks provide funding for private-sector growth and act as the conduit for the distribution of government funding for the public sector. Yet, during a crisis, GCC banks are in a stronger position due to their large reserves, unlike the rest of the MENA region, which has no such source of cash deposits. During crises, while corporate governance in other MENA countries emphasizes the monitoring of bank management’s ability to increase liquidity for bank loans, in the GCC, independent directors may require that management reduce nonperforming loans.
The second research gap lies in the influence of political connections on bank performance. The current knowledge of such connections is either anecdotal or confounded by a country (Lebanon) that was in crisis due to non-COVID-19 lockdowns. Attalah and Tamo
) enumerate the ownership of up to 54% of a Lebanese bank owned by two family members, while two former government ministers became the majority shareholders of a bank. A single study of Lebanese banks in 2021–2022 determined empirically that the presence of independent members on the board of directors, as well as the presence of audit, risk, and compliance committees, increased profitability. However, political connections increased the level of nonperforming loans (El-Chaarani and Abraham 2022
). We expand both the sphere (the entire GCC) of examination and separate non-COVID-19 crises, such as the Lebanese financial crisis of 2021, from pandemic-induced crises.
From a practical standpoint, this study could assist bankers in identifying the ideal governance strategies that are consistent with the level of legal protection adopted. This study could identify the optimal governance structure that enhances performance and mitigate the negative impact of crises.
The remainder of this paper is organized as follows. Section 2
is a Review of the Literature; Section 3
consists of hypotheses development; Section 4
is Methods and Materials; Section 5
is Results; Section 6
consists of Conclusions.
6. Conclusions and Discussion
6.1. Summary of Findings
The findings of this study may be summarized as follows.
For GCC banks, independent directors on the board increased the return on assets and the return on equity in the pre-crisis and crisis periods.
For GCC banks, ownership’s political concentration increased the return on assets and the return on equity in the pre-crisis and crisis periods.
For GCC banks, managerial political connections had no effect on the return on assets and the return on equity in the pre-crisis and crisis periods.
For GCC banks, bank size increased the return on assets and the return on equity during the crisis period.
For GCC banks, the liquidity ratio increased the return on assets and the return on equity in the pre-crisis and crisis periods.
6.2. Theoretical Implications
This paper has expanded our knowledge of the influence of corporate governance variables on profitability by conducting an empirical examination during a financial crisis, i.e., the COVID-19 lockdown of 2020–2021. Although up to eleven corporate governance variables and institutional variables have predicted profitability in the literature, during the crisis, just four variables acted as predictors. They included the presence of independent directors, ownership’s political concentration, bank size, and liquidity ratio. Each of these findings will be discussed in depth in the following sub-sections.
6.2.1. Independent Directors
The importance of independent directors in the GCC is similar to the finding by El-Chaarani et al.
) in the MENA region of independent directors significantly influencing both return on assets and return on equity during the COVID-19 lockdown. Independent directors may have played contrasting roles in both studies. In the MENA region, the lower income of bank depositors and borrowers, along with the findings of Mdaghri
) and Sahyouni and Wang
), suggest that there is a large volume of nonperforming loans. Independent directors may be engaged in monitoring management’s ability to reduce nonperforming loans. In the GCC region, higher incomes suggest that the emphasis may be on maintaining the accounts of large depositors. Independent directors monitor the ability of managers to offer higher interest rates for large deposits, waive fees and charges on new accounts with large balances, and create new deposit instruments, such as certificates of deposits, that offer competitive interest rates.
6.2.2. Ownership Political Concentration
We extend Boussada and Hakimi
) finding of the significant positive impact of the presence of large shareholders on return on assets and return on equity in the MENA region to the GCC countries. We specify that it is the ownership’s political
concentration that increases profitability during crises, as institutional political concentration and foreign ownership concentration yielded no impact on profitability. The presence of politicians on bank boards, be they retired military, or former ministers, is beneficial, as they have direct access to members of government. During the pandemic, certain businesses received large government bailouts, including banks. Such politician-directors could have solicited bailout funds for their own businesses. Such funds were converted into new loans, which increased bank net interest income and bank profitability. Further, these individuals helped to maintain relationships with existing large depositors, who may have been family members or close friends.
6.2.3. Bank Size
The significant effect of bank size on profitability was confined to the crisis period. During the crisis, large banks continued to offer loans due to their large reserves. Although loan interest income was sufficient in the pre-crisis period, it was insufficient to sustain bank profits during the crises. Size helped large banks to locate alternate revenue streams, such as loan commitments, derivatives, and letters of credit.
6.2.4. Liquidity Creation
Liquidity creation has been recognized as a core function of banks in that banks take funds from depositors. Liquidity creation was a more important predictor of return on assets before the crisis, although it became a more important predictor of return on equity during the crisis. Return on equity is returned to the shareholders. As creating loans was more challenging during the crisis, banks that created such loans may have been viewed by shareholders as creating wealth. The equity of such investors may have risen in value as their confidence in bank loan creation increased.
6.3. Other Theoretical Implications
To our knowledge, there is no study that showed the interaction between political connections and corporate governance mechanisms and its impact on the financial performance of the GCC banking sector. Thus, this research fills this gap and extends the research work on corporate governance mechanisms in banking firms. Furthermore, the previous studies were performed based on small samples of selected banks in the GCC region without considering the crisis periods. Therefore, this study contributed to the corporate governance field by using a larger sample studied during the crisis period. Finally, this study provides a partial confirmation of several theories such as agency and entrenchment theory. Agency costs occur with managerial political connections. However, ownership’s political concentration, and independent directors, overcome these agency costs, as both of these variables significantly increase profits. Managerial entrenchment may result in revenue-reducing strategies. However, independent directors’ monitoring of management’s ability to make rational decisions during crises may have prevented such losses.
The finding that, during the COVID-19 crisis, the GCC did not benefit from a compensation committee or CEO duality, as observed during the 2007–2009 financial crisis (Ayadi et al. 2019
), is significant. These corporate governance mechanisms contributed to the hiring of resourceful CEOs to cope with the 2007–2009 financial crisis. In the GCC countries during the COVID-19 lockdown, the political connections of large shareholders in obtaining deposits may have been the more effective coping strategy.
6.4. Practical and Policy Implications
This paper has several implications for bankers, governments, and financial regulators.
Bankers know that preparation for the next financial crisis is essential. GCC banks must place independent directors on the board and encourage large shareholders to use their political connections to obtain access to government resources. As bank size is important during crises, small banks may form consortiums with mid-size banks so that they will have the funds to continue to make loans, even in times of economic instability.
Above all, banks must strive to maintain liquidity, or sufficiently large cash reserves, to be able to make loans during regular periods and crises. It is loan creation that provides the interest income that permits banks to perform their essential role of financial intermediation. As mentioned, smaller banks must seek partnerships with larger entities that will enable them to access funds. Government programs targeted at small banks may provide a steady stream of funds. Banks are encouraged to apply for such government funding, even during prosperous periods, so that they become established borrowers. Large banks may have reserves or political connections to obtain these funds.
6.5. Limitations and Research Plans
This study has several limitations that could be considered in future research papers. First, this paper is based on a small sample and considers a very short period. Only four years and 88 banks were considered in this study; thus, future research papers must be performed by considering larger samples and periods.
Second, in regression models, this paper does not consider the impact of corporate governance and political connections within each country in the GCC. Therefore, future work can be performed by studying the impact of corporate governance and political connections on the financial profitability within each GCC member country.
The employed dependent variables could be extended to include other variables related to market risks and market performance. Finally, future research papers could include other corporate governance variables, such as legal protection and takeover strategy.