Exploring the influence of micro, small and medium enterprise financing and dual banking stability: evidence from Saudi Arabia

Purpose The purpose of this study is to examine the impact of micro, small and medium enterprises (MSMEs) financing on the stability of Saudi Arabia’s dual banking system. Design/methodology/approach This study uses the correlated random effects (CRE) model, which is selected based on the Mundlak test. The CRE model is more appropriate for small sample data sets. MSME financing data is sourced from the annual reports of Saudi Arabia’s three full-fledged Islamic banks (FIBs) and six hybrid conventional banks (HCBs) over the six-year study period from 2018 to 2023. Findings The findings show that MSMEs financing has a statistically significant positive impact on the overall banks Ln Z-Score (stability) and a negative impact on nonperforming loans (credit risk) emphasizing the positive impact of MSMEs financing on the dual banking system stability. However, when the authors disaggregate and estimate separately for FIBs and HCBs, the authors find that micro and small-sized enterprises (MiSEs) financing positively impact the stability of FIBs, but only small-sized enterprises financing reduces their credit risk. For HCBs, however, only medium and microsized financing have statistically significant positive impact on their stability and a negative impact on their credit risk, respectively. These findings are economically significant and remain robust when the authors estimate for both on-and-off-balance sheet, and MiSEs and SMEs financing for overall banks. Practical implications The findings offer some important policy insights for policymakers and regulators of developing countries with dual banking systems in general and Saudi Arabia in particular that MSMEs financing enhances the stability of dual banking system and reduces their credit risk. This favorable impact is more evident for FIBs. The fact that Saudi Arabia FIBs having larger portfolios of MSMEs financing relative to their conventional counterparts have impacted their stability favorably which implies that policies favoring MSMEs financing can enhance both the financial sector and the underlying real sector in which MSMEs operate by reducing income inequality, enhancing financial inclusion and fostering entrepreneurship, which will consequently lead to long-term financial stability and to sustainable economic growth and societal development. Originality/value To the best of the authors’ knowledge, this is the first study that empirically examines the impact of MSMEs financing on the stability and credit risk of a dual banking system. The study provides new evidence substantiating that bank MSMEs’ financing can be a win-win proposition.