Determinants of Capital Adequacy Ratio of Deposit Money Banks in Nigeria

Abstract

Capital Adequacy Ratio (CAR) is an important measure of “safety and soundness” for banks and depository institutions because it serves as a buffer or cushion for absorbing losses. It is one of the major benchmarks for financial institutions the world over, especially with the introduction and adoption of the various Basel Accords. This study is an attempt to analyze the bank-specific determinants of CAR in the Nigerian Deposit Money Banks (DMBs) using balanced panel data collected from financial statements of 12 selected quoted banks for the ten-year period 2005-2014. The index for profitability which is ROA was found to be the most important determinant of CAR, having recorded the highest coefficient in the multiple regression result. The study found out that Capital Adequacy Ratio of Nigerian deposit money banks is well above the regulatory minimum set by CBN as well as the requirements of Basel Accord. Also, Nigerian banks’ risk portfolio is quite high and ROA is quite low. Depositors’ interests are well protected as the asset base of DMBs is well above the total deposits. The study concludes that CAR is largely determined by banks risk-portfolio, deposit level, profitability and asset quality and that CAR of Nigerian banks is well above the regulatory minimum. The study recommends that Nigerian deposit money banks should adopt a more pragmatic risk-management mechanism and a risk-based capital maintenance approach backed by a robust data management system. The study recommends improvement in operational performance of banks, strict compliance with various capital regulations, frequent stress tests for banks and more detailed disclosure practice to include details of changes in Tier I and Tier II capital, risk-weighted assets and trend analysis of changes in Capital Adequacy Ratio.

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