Interest rate, foreign exchange and stock performance in a dual banking industry: evidence from Saudi Arabia

Purpose - This study aims to extend the literature by extensively investigating the impact of foreign exchange and interest rate changes on the returns and volatility of bank stocks in Saudi Arabia, which is the largest dual banking industry. Design/methodology/approach - This study employs the generalized autoregressive conditional heteroscedasticity (GARCH) model on stock returns of four fully Islamic Saudi banks and eight conventional Saudi banks. Findings - The results showed that the foreign exchange rate return has a positive impact on Saudi conventional bank returns, while it has an adverse impact on Saudi Islamic bank returns. Moreover, a higher interest rate return has a positive impact on Saudi bank stock returns implying that the assets side is more sensitive to changes in interest rates than the liability side. Finally, higher foreign exchange and interest rates volatility increases the volatility of Saudi bank returns, where the former has the largest significant impact. Therefore, Saudi regulators should pay more attention to the risk management of their banks because this could threaten the stability of their financial system. Originality/value - To the best knowledge of the author, this is the first study that tries to extensively analyze the joint impact of foreign exchange and interest rates on bank stock returns and volatility in Saudi Arabia by applying the GARCH model. The study uses a long data set from 2010 to 2019 that includes all Saudi banks and employs four measures of interest rates to increase the robustness of the results.