The Effect of Capital Adequacy Regulations on the Financial Performance of Deposit Money Banks in Nigeria.

Abstract

The ongoing distress in the Nigerian banking sector raises the question of whether the current regulatory framework is effective in both ensuring financial system stability and enabling banks to earn profits for their shareholders. Among the requirements, the capital adequacy regulations are of particular concern: do they strengthen the stability of the financial sector or constrain banks' ability to deliver returns to shareholders? This study examines the effect of capital adequacy regulations on the performance of deposit money banks in Nigeria. The survey period is from Q1 2015 to Q1 2025. The study used return on equity as the measure of bank performance (dependent variable) and capital adequacy ratio as the independent variable. Asset quality and liquidity were considered as control variables. The inflation rate was included to account for external shocks. Appropriate econometric analysis was conducted using the Autoregressive Distributed Lag (ARDL) bounds testing approach. The major finding is that capital adequacy regulations have a significant adverse effect on bank performance in both the short and long run. Asset quality has a considerable influence, while liquidity and inflation do not. Other tests for model selection, stability, serial correlation, heteroskedasticity, and normality confirm the model's suitability. The study concludes that while capital adequacy regulations are necessary for systemic stability, their strict enforcement at high levels can constrain bank profitability. Policymakers need to strike a balance by adopting a risk-sensitive approach to capital regulation, enhancing asset quality management, applying countercyclical capital buffers, and introducing discretionary flexibility during economic shocks. These recommendations align the goals of prudential supervision with banks' dynamic performance objectives, thereby improving outcomes for the macroeconomic environment in which these banks operate. Overall, policymakers, regulators, and capital bank managers can benefit from the study's findings by ensuring that banks operate with adequate capital levels that support, rather than hinder, performance in Nigeria's banking sector.