Corporate Governance Effects on Bank Profits in Gulf Cooperation Council Countries during the Pandemic

TL;DR: In this article , the authors show that the ability of banks to employ corporate governance to cope with liquidity crises is demonstrated by using OLS regressions followed by two-stage least squares and GMM estimator robustness checks of ownership political concentration, independent directors, bank size, and bank liquidity.

Abstract: During the COVID-19 lockdown, the typical bank in the Middle East lost liquidity due to deposit drains and experienced increases in nonperforming loans. The loss of liquidity was a supply shock, while the increase in nonperforming loans was a demand shock. Corporate governance increases the board’s oversight of top management’s implementation of strategies to reduce these shocks. Two corporate governance measures include a political concentration in the ownership and the presence of independent directors on the board of directors. Politically connected shareholders can ensure the continuous flow of deposits through their access to large depositors, thereby reducing supply shocks. Supply shocks may also be overcome by the large deposit balances from oil wealth. Independent directors are not employees of the banks on whose boards they serve, thereby providing objective evaluations of management’s performance. Managers who are evaluated by independent directors can reduce nonperforming loans by strictly evaluating the creditworthiness of borrowers and providing incentives for timely repayment. Thus, demand shocks may be overcome by the scrutiny of management by independent directors. These conditions prevail in the Gulf Cooperation Council (GCC countries). Using a sample of 326 GCC banks, we perform OLS regressions followed by two-stage least squares and GMM estimator robustness checks of ownership’s political concentration, independent directors, bank size, and bank liquidity on returns on assets and equity. Ownership political concentration, independent directors, bank size, and liquidity ratio significantly explained the return on assets and on equity. We conclude that large shareholders use political connections to cope with crises and that large banks are able to make new loans due to liquidity from large reserves. Independent directors evaluate management performance objectively, thereby requiring that management reduce nonperforming loans. We close research gaps of bank performance in GCC countries, as opposed to the entire MENA region, the latter being the focus of the literature. The significance of this paper is that it demonstrates the ability of banks to employ corporate governance to cope with crises. This is an original approach, as it seeks the outcome of a positive signal on bank performance of the reduction in the supply shock through ownership political concentration and reduction in the demand shock by independent directors. As corporate governance variables mitigate both shocks, corporate governance may assist banks in coping with liquidity crises.