THE IMPACT OF BANK CAPITALIZATION IN THE PERFORMANCE OF NGERIAN BANKING INDUSTRY (1986-2006)
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The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
THE IMPACT OF BANK CAPITALIZATION IN THE PERFORMANCE
OF NGERIAN BANKING INDUSTRY (1986-2006)
DR IKPEFAN, Ochei Ailemen, Ph.D, ACA, by Central Bank of Nigeria (CBN) in order to
ACIB1 sanitize the banking industry. Soludo, (2004)
ABSTRACT noted that the vision or prospect of the CBN and
This study investigates the impact of the Federal Government of Nigeria is a banking
shareholders’ fund on bank performance in the system that is part of the global change, and
Nigerian deposit money banks (1986-2006). The which is strong and reliable. It is a banking
study captured their performance indicators and system which must be efficient, depositors can
employed cross sectional and time series of trust and investors can rely upon. Bank
bank data obtained from Central Bank of capitalization is the act of supplying long-term
Nigeria (CBN).The formulated models were funds to a bank in order to place the bank on a
estimated using ordinary least square regression good position to carry out the business of
method. The study identified a positive banking. Bank recapitalization is the act of
relationship between shareholders fund and beefing up the long-term capital of a bank to the
bank loan. We also find that there is significant
level at least required by the monetary
relationship between shareholders’ fund and
authorities and to ensure the security of
banks’ liquidity, bank deposits, and bank loans.
shareholders fund (equity plus reserve).
The efficiency of management measured by
On the other side, capital cannot perform
operating expenses is negatively related to
without good management by those at the top
return on capital. The implication of this study,
echelon of the organization. Capitalization in
among others, is that adequate shareholders
fund can serve as a veritable stimulant in this study refers to a number of variables of
strengthening the performance of Nigeria interest which are produced from the existence
deposit money banks and also heighten the of funds for use in the process of intermediation.
confidence of customers especially in this era of From these funds, obviously concepts such as
global economic melt-down that has taken its Return on Capital (ROC) and Shareholders Fund
toll in the Nigerian financial system. (SHF) are derivatives from the use of funds.
Management needs to employ the assets and
Key words: Buffer capital theory of capital capital of the bank judiciously for positive
adequacy, Deposit insurance theory, Expense results. Absence of corporate governance has
theory, Central Bank of Nigeria. been attributed to the distress experienced in the
JEL classification: E44, E5, G21. banking industry in the past. The CBN
Governor noted that the vision or prospect of
INTRODUCTION the CBN and the Federal Government of Nigeria
The focus of this study is on Nigerian deposit is a banking system that is part of the global
money banks formerly called (commercial change, and which is strong and reliable. It is a
banks), and merchant banks which had been the banking system which must be efficient,
target of recapitalization. With the depositors can trust and investors can rely upon.
implementation of Universal banking by the This was the Consolidation era (2004- 2008). It
Central Bank of Nigeria (CBN) on January 2001 was the era of “13-point Reform Agenda for
a level playing ground was created for all banks Repositioning the CBN and the Financial System
in Nigeria. The recapitalization policy is just for the 21st Century”. The issue of bank
one of about 13 issues announced in July 2004 capitalization in most economies today has been
how to resolve the problem of unsound bank,
enhance efficient management of the banking
1 system, provide better funding for banks
Department of Banking & Finance, Covenant
lending activities, reduce non-performing loans
University, Ota, Ogun State
and advances, increase profitability, reduce risk,
E-mail Ochei_Ikpefan@yahoo.Co.Uk;
Tel 08053013418 to ensure quality asset management and to put
banks in a strong liquid position to meet
24The impact of banking capitalization on the performance of Nigerian banking industry
customers obligation at all times. For instance, weakness inhibits bank management in the
the distress that was pervasive in the Nigerian performance of its development roles in the
banking system in the mid-1990‟s and early 2000 economy, thus hindering the achievement of
was due to amongst others, illiquidity in the government objectives such as price stability,
banking system which led to the lost of macroeconomic stability, provision of
customers confidence in the banking industry. employment and increased output. It also affects
The move by the CBN to raise the minimum the ability to compete effectively in the
paid up capital of banks to N25 billion in 2005 international market. Since the banking sector is
was aimed at strengthening the Nigerian the hub around which all other economic
banking industry. It is imperative that for banks activities revolves, the health and prosperity of
to meet up the required level of capital for the bank is a major source of concern to
sound and safe banking. Capital adequacy is Nigerians especially the regulators. According
important for banks to absorb risks till banks are to the Governor of Central Bank of Nigeria cited
able to generate profit. However, banks that are in Egene (2009), of the ten (10) banks audited so
able to exceed the capital requirement stand a far as at August 2009, the banks‟ balance sheets
better chance of luring customers and instilling of five banks (Union bank, Finbank, Oceanic
confidence in the system. The Nigerian banking bank, Afrique bank and Intercontinental bank)
industry has been affected by inconsistent had shrunken, shareholders‟ funds impaired
monetary policies, unstable macroeconomic and they now have liquidity problems. Their
variables such as exchange rate, interest rate and huge exposure to non-performing loans (margin
general inflation some of which have led to loans) has affected the banks. These banks had
increase in prices of capital and consumer goods spent length of time at the expanded discount
thus, lowering effective purchasing power of window (EDW) introduced in September, 2008
people and reduced aggregate demand. Like by the apex bank. These five banks accounted
other sectors, this sub-sector is also faced with for 90% of transactions at the EDW. The
poor infrastructural facilities and poor remaining banks accounted for 10%.According
performance of regulatory authorities. to the apex banks, these banks took money from
According to Ajekigbe (2009), from the classical the inter-bank to repay their exposure to the
and historical perspective, “several factors led to discount window. It is an indication that their
the failure of banks between 1977 and earlier 2000. balance sheets had shrunk. The management
Some of the reasons advanced are poor asset quality, teams had acted in a manner that was
under capitalization, inexperienced personnel, detrimental to the interest of their depositors
illiquidity, inconsistent regulatory policies and and creditors. According to the apex bank, the
supervision”. temporary capital injection of N420 billion into
The evolving competition in the banking the banks in the form of Convertible Tier 11
industry as a result of globalization has made it Debt, is expected to be repaid to the CBN once
difficult for Nigerian banks to play their major the banks are recapitalized. Considering the fact
role of financing economic activities arising from that ownership of banks has moved from family
inadequate capital. Inadequate bank capital has to private, existing shareholders have not been
led to a crisis of confidence in the banks to the informed how these funds would be converted
extent that the original functions which is to when the bailout fund is fully repaid. The
support the volume, type and character of a measure adopted by CBN to bail out the banks
bank‟s business, to provide for the possibilities is adjudged as misuse of taxpayers‟ money and
of losses that may arise there from and to enable may eventually displace existing shareholders.
the bank to meet a reasonable credit need of the The last few years have both been traumatic and
community have been eroded. Losses suffered revolutionary for the Nigerian banking system.
by banks led to bank failure especially in the According to Eke (1999): “Since the introduction
areas of lending. The soundness, safety and of structural adjustment programme (SAP) and
profitability of a bank affect the quality of its the deregulation of the nation‟s financial system,
loan portfolio. banking business has raised a variety of
In the past, the Nigerian banking industry had performance questions. Although some insured
been plagued with small size banks with low banks had recorded an appreciable increase in
capital and high cost of operations. This the volume of assets and deposits, their overall
25The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
financial condition had deteriorated (iii) The extent to which
tremendously”. Performance indicators of banks macroeconomic variables such
such as capital adequacy, asset base, as interest, inflation and
management capability, earnings (return on exchange rates have affected
capital employed) and liquidity have been capitalization in the banks.
adversely affected while variants of bank Section 1 above discusses the introduction;
performance such as bank deposit, bank loan, Section 2 examines the conceptual framework
operating expenses have also deteriorated. and literature while Section 3 discusses the
Crisis of confidence has affected bank deposit method of analysis. Section 4 dwells on the
mobilization and loan extension to customers. estimation, model specification and discussion
The situation is made worse by the adverse of results. Section 5 ends the paper with
effect of macroeconomic variables such as summary, findings and recommendations. We
exchange rate, interest rate and inflation. While shall now proceed to examine some conceptual
there have been several studies on bank and theoretical underpinning of this paper.
capitalization and performance very few of
them have focused on bank capitalization and THEORETICAL FRAMEWORK AND
performance of the Nigerian banking industry. LITERATURE REVIEW
Several studies about bank capitalization exist in Buffer Theory of Capital Adequacy
United Kingdom (UK), United States (US) and Banks may prefer to hold a „buffer‟ of excess
Asia, Africa, South Africa and Tunisia. capital to reduce the probability of falling under
However, the extent to which such research the legal capital requirements, especially if their
findings can be applied to Nigerian banking capital adequacy ratio is very volatile. Capital
industry should be studied. Therefore, this requirements constitute the main banking
study hopes to establish the relationship that supervisory instrument in Nigeria. The Central
exists between shareholders fund, bank deposit, Bank of Nigeria (CBN) intervenes little in banks‟
bank loan and bank liquidity and activities but does directly conduct on-site
macroeconomic variables. The empirical study examination and at times delegating this task to
that will be carried out on this study will fill the external auditors. By contrast, a breach of the
gap in the existing literature especially as it capital requirements is considered a major
relates to variables that affects bank infringement of banking legislation and is not
performance. Therefore, this study is an attempt tolerated by the Central Bank of Nigeria (CBN).
to investigate the impact of shareholders fund Banks remaining undercapitalized for
on variants of bank performance in the Nigerian prolonged periods are closed. The withdrawal of
deposit money banks. The following dependent some banking licenses at the expiration of the
variables are used as indicators for gauging recent recapitalization of banks in Nigeria in
bank capitalization: return on capital (ROC) and 2005 is a pointer to this fact. Banks will require
shareholders fund (SHF). The questions being more capital if deposits are not fully mobilize
asked are: does capitalization reduce the from the public. Capital is more reliable,
operational expenses of the banks?. Increase dependable and can be used for long term
capitalization reduces the operational risk and planning. Ability of banks to mobilize enough
bank failure? To what extent does shareholders deposits obviates the capital base from being
fund affect bank deposit, bank loan and eroded. The buffer theory of Calem and Rob
liquidity? The objectives of this study are (1996) predicts that a bank approaching the
(i) To determine if bank regulatory minimum capital ratio may have an
capitalization has influenced the incentive to boost capital and reduce risk in
growth of bank deposit, bank order to avoid the regulatory costs triggered by
loan and liquidity; a breach of the capital requirements. However,
(ii) The extent to which operation poorly capitalized banks may also be tempted to
expenses have impacted on the take more risk in the hope that higher expected
return on capital; returns will help them to increase their capital.
This is one of the ways risks relating to lower
26The impact of banking capitalization on the performance of Nigerian banking industry
capital adequacy affects banking operations. In bank failure. Therefore, regulation of bank risks
the event of bankruptcy of a bank, the risks are exposure is necessary to reduce the expected
absorbed by the bank, customers and Nigeria losses incurred by the deposit insurance
Deposit Insurance Corporation (NDIC). At corporation.
present NDIC pays a maximum of N200,000 to a Deposits solicited from customers are not as
customer in the event of bank failure. Hence, dependable and reliable as the bank capital
customers are concerned about capital position requirement. It cannot be used for long term
of banks at all time. Banks are expected to insure planning. However, more deposits means banks
and pay 15/16 of customers deposit liabilities can grant more loans and will not obviate the
multiplied by 1% to NDIC to enable their need for excessive capital. Where bank loans
customers benefit from the scheme. The above and advances are given out to customers
practice of NDIC in Nigeria is applicable to without due process it might affect capital and
other countries but varies in amount. liquidity position of a bank in the long run.
In model 1 of this study, capital our dependent
variable which is represented by shareholders Expense Theory
fund (SHF) and explained by our buffer theory According to the expense theory of Williamson
of capital adequacy helps us to test the (1963) cited in Nyong (2001) otherwise called the
propositions in hypothesis one. The higher the theory of managerial discretion, managers have
shareholders fund the better is bank liquidity the option in pursuing policies, which maximize
and capital adequacy. The Deposit insurance their own utility rather than profit maximization
scheme, which is compulsory in Nigeria, also for shareholders. Such utility include the
exerts regulatory pressure on banks. In his satisfaction which mangers derive from certain
study, Vojta (1980) opines that adequate capital types of expenditure. Managers‟ prestige, power
provision against excess loss permits the bank to and status are to some extent reflected in the
continue operations in periods of difficulty until amount of slack they receive in the form of
a normal level of earning is restored. The expense account, luxurious offices and building,
benchmark set by regulators of bank capital company cars and other perquisites of office.
sometimes differs from those of the bankers. Operating efficiency attempts to capture this
These capital standards have led to questions on aspect of bank behaviour. Operating expenses
whether or not regulators have been able to captured by (EOM) is represented in model 2 as
bring about changes in bank capital when their one of our control variables to explain the
standards of capital adequacy differed from dependent/regressand that is return on capital
those of bankers. Aggressive banks may try to (ROC). Operating expenses is derived from the
extend the frontiers of “imprudent management use of resources and can have positive or
policy” by operating with less capital base, often negative implication on the dependent variable.
in violation of the regulatory guidelines. But the
supervisory agencies usually stand their ground LITERATURE REVIEW
by resisting decline of capital to avoid bank Okazaki and Sawada (2006) investigated the
failure with the concomitant high cost to the effects of policy consolidation on the stability of
society. the financial system. The study found that
consolidations had a negative effect on ROA,
Deposit Insurance Theory which indicates that consolidations led to
The deposit insurance theory also provides an inefficiencies, and that this dominated the effect
insight into the behaviour of commercial banks of increased market power, if any such increase
(Flannery, 1989; Cham, Greenbaum and Thakor, occurred. The Nigerian Banker (2004) on 2004
1992). In the context of this theory, banks are monetary policy implementation observes that
viewed as portfolio of risky claims. As insured in fiscal 2004 and 2005 the CBN expected banks
banks increase their risk of failure without limit, and other financial institutions to operate in
there is an expected value transfer of wealth such a way as to remain liquid at all times and
from government deposit Insurance avoid the spectre of overdrawn accounts and
Corporation to bank owners. Regulators are being sent of clearing. The CBN (2004) “rating of
concerned about bank‟s soundness, particular licensed banks using CAMEL parameters shows
with respect to solvency or the probability of
27The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
that 10 banks were “sound”, 51 were linear models to estimate the impact of various
“satisfactory”, 16 rated “marginal” while 10 factors that may be important in explaining
were rated unsound as at the end of 2004. The bank performance. Aburime (2008) in his study
report also showed deteriorating performance of the determinants of bank profitability:
with 17 banks (18.89%) rated either marginal company-level evidence from Nigeria; elicited
and /or unsound out of 90 banks in 2001, while his data from the public financial statement of
26 banks (29.89%) of the 87 banks in existence in an unbalanced panel (Athanasoglou et al., 2005
2004 rated either marginal and/or unsound. The and Baltagi, 2001) of 33 commercial and
marginal and unsound banks were considered merchant banks in 91 observations over the 200-
to have exhibited such weaknesses as under- 2004 period.
capitalization, illiquidity, weak/poor asset Osinubi (2006) in his study of the effects of
quality, poor rating”, etc. recapitalization on financial performance in
Nwude (2005) identified the imperatives for selected banks 2001-2005, found that the asset
bank recapitalization in Nigeria to include too quality of the Nigerian banking industry does
many banks with sizes being too small to not depend on its capital base. The study
support any sound banking business; stunted calculated the CAMEL ratios for each of the
growth of the real sector arising from selected banks and relates these to their capital
incapability of bank capital ratio and size to base. Data was collected on shareholders‟ fund,
fund industrial development; high lending rate which constitutes the bank‟s capital base; data
and shunning of real sector, and unprofessional was also collected on the total asset, classified
and unethical practices. Others include the need loans, Earning before interest Taxes (EBIT) and
to promote public confidence in the banking Gross Loans and Advances. Using the CAMEL
sector; curtailment of excessive risk taking by indicators, the study found that the asset quality
banks; reduction in the incidence of insolvency of the Nigerian banking industry does not
and distress and the need to dilute ownership depend on its capital base. However, the study
structure giving rise to professionalism. All shows that the more the capital base the higher
equity firms are characterized by greater the liquidity and capital adequacy of the
liquidity positions than levered firms. Bank use banking industry. The return on assets also
a mix of debt but more of equity in their increases as the firm‟s capital base increases.
financing. Empirical evidence from Naceur and Goaied
Some studies of the Nigerian banking industry (2001) indicate that the best performing banks
have linked characteristics of individual bank are those who have maintained a high level of
companies to profitability. These studies include deposit accounts relative to their assets.
Nwosu and Nwosu (1998), Uche and Ehikwe Increasing the ratio of total deposits to total
(2001), Beck, Cull and Jerome (2005) and assets means increasing the funds available to
Brownbridge (2005). In the main, their studies use by the bank in different profitable ways such
link capital base (Nwosu and Nwosu, 1998), as investments and lending activities. The
lending activities (Beck et al., 2005) and performance of commercial banks is influenced
Brownbridge, 2005), information technology by a host of factors some of which are
(Uche and Ehikwe, 2001), management quality macroeconomic, institutional, regulatory and
(Nwosu and Nwosu, 1998) and Brownbridge, legal. Uchendu (1995) posited that in attempting
2005) and Bank size (Brownbridge, 2005) to the to maximize profits; banks must do so under
profitability of banks in Nigeria. However, capital adequacy and liquidity considerations.
among all these studies, only Beck et al (2005) He noted that the regulatory influences of
employed the intricacies of econometrics in monetary authorities include those on interest
deriving their conclusions. The majority of and exchange rates, bank reserves (indicating
studies on bank performance, such as Short credit availability), labour costs or productivity.
(1979), Bourke (1989), Molyneux and Thorton Yudistira (2003) in his study of bank capital
(1992), Demirguc-Kunt and Huizinga (2001), requirement in Indonesia found that there is a
Goddard, Molyneux and Wilson (2004) and strong positive relationship between bank
Athanasoglou, Brissimis and Delis (2005) use capital and the growth rate of bank deposit.
28The impact of banking capitalization on the performance of Nigerian banking industry
Secondly, the results from the effect of deposits of the nation‟s deposits and savings. There were
and loans showed that poor capitalized banks eighty-nine commercial banks in Nigeria before
operated with low net worth relative to asset. the 2005 bank recapitalization exercise and the
number has been reduced to twenty-five banks
METHOD OF ANALYSIS after consolidation and to 24 (after merger of
This section tries to capture empirically the IBTC & Stanbic bank to Stanbic-IBTC) in 2008.
relationship between bank capitalization and Of the twenty –four banks, four of them that is:
performance. When we speak of bank Unity bank, Sterling bank, Spring and Skye
capitalization we are referring to variables such banks are new creation of mega banks. A sample
as Return on Capital and Shareholders fund. size of fourteen out of the twenty four
Therefore, our equations looks at the extent to commercial banks was employed in the study.
which these variables are brought into light or The sample (of fourteen commercial banks) was
the realization is facilitated by the existence of drawn from both the old and new generation
what we generally referred to as adequate banks using the Stratified sampling technique
capitalization. Availability of funds facilitate based on simple random sampling supported by
ROC buoy up SHF. Thus, the kernel of this Judgment Sampling (See table 1). The selection
paper is to examine how bank capitalization and process is restricted to banks quoted in the
performance have been enhanced by bank Nigerian Stock Exchange Daily official List
consolidation. Further, the crux of this paper is (SEDOL).
to see how bank capitalization and consolidation Insert table-1 here
in Nigeria make funds available for the The sample drawn from the population was
realization of adequacy of capitalization and grouped into categories based on the size of
performance. Obviously, we can only look at a their capital as at the 2006. The sample size
number of years given the fact that bank consists of both old and new generation banks.
consolidation took place only three years ago. Banks that commenced operation before 1988
This is what makes it impossible to make use of are old generation banks while those that
time series analysis because we have only two commenced operation from 1989 are new
years to seriously discuss issues. This is why the generation banks. Amongst others new
use of panel data is preferred in this exercise to generation banks started aggressive marketing a
time series analysis. Also, we have not used departure from armchair banking which old
cross sectional data analysis in this paper generation banks were noted. New generation
because it is not possible to complete set of data banks also introduced new technology for
on any bank for any particular year if only efficient service delivery change. There is a
because merger has taken place randomly and modified sample size for banks in this study.
banks have also come into existence randomly. Since this study is between 1986-2006, banks that
The panel data methodology provides a useful are not quoted are eliminated because their data
answer to all these. Hence, the choice. This are not readily available. During the field work,
paper uses the econometric approach in it was observed that these banks had no data
estimating the effect and to be specific it uses the bank for their Annual financial statements.
E-view software employing panel of data. Hence, such banks are not considered. Thus in
our sample size banks such as Nigerian
Population and Sample Size International Bank, Standard Chartered Bank,
The population of this research is drawn from Equatorial Trust bank that are not (listed)
the Nigerian banking industry (deposit money quoted were eliminated and this reduced our
banks) that is deposit-taking institutions. This is population of study to twenty-one. This
because they dominate the financial sector in represents 14/21 (67%) of the quoted banks in
terms of number and coverage. Despite the Nigeria.
involvement of other financial institutions such The study analyses the data as contained in the
as non-bank financial institutions - insurance financial report of 14 commercial banks out of
companies, development banks, finance houses, the 24 banks operating in Nigeria as at the end
etc -in the intermediation process, deposit of 2006, representing about 60% of the
money banks still control the major proportion commercial banks and about 67% of the quoted
banks. The bank data were obtained from CBN
29The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
Banking Supervision and Annual Reports, banks on a piece of paper, wrapped and put in a
(2006-2007) and Annual financial Statements tray from where they were picked. Our table
from various years of the selected banks for the above shows that of the 13 banks (12 banks
years 1986 -2006 are used for the analysis. The excluding non-quoted banks) fall into the
end of the cut-off date represent just one year frequency of bank capital between N35 billion
after the bank consolidation mandate of 2004 by and above that is 2/3 multiplied 12 gives 8. The
the Central Bank of Nigeria which took effect on following banks were picked Oceanic bank,
31st December, 2005. The study of bank Guaranty Trust bank, Intercontinental bank,
capitalization and performance thus covers the First bank of Nigeria, Union Bank of Nigeria,
period from the structural adjustment program United Bank, Zenith and IBTC/Stanbic bank
of 1986 to 2006. The period of 1986 was the At the of end of the selection process, 60% that is
beginning of bank deregulation and six (6) out of the nine (9) banks fall into the
liberalization (more banks were licensed) while frequency of between N25 billon < N34.9 billion
we projected from 2005 the commencement year while 72% that is eight (8) banks out of the
of the study to a cut-off date of 2006 (one year twelve (12) banks fall into the frequency of
after bank consolidation) when financial between N35 billion and above. The selection
statements of banks are expected to be available. process picked 50% (seven) of the old generation
Audited bank financial statements most time fall banks and 50% (seven) of new generation banks
in arrears. As stated earlier, this study employed (See table 1 above).
the Stratified Sampling Technique. In stratified
sampling, the population is categorized into The Panel Data Method
groups that are distinctly different from each Instead of using time series data or a cross
other on relevant variables. Each group is called section of banks, this study looks at a panel data
stratum (plural strata). In applying stratified specification for individual banks. In Cross
sampling, we categorized the population and section analysis, data are collected across units
stratified using bank capital (See table 1) above. of observation at a given point in time. For cross
In this study, the elements in a particular section unit we observe the same attribute on
stratum are the same with respect to the relevant different people, geographical units, etc using
parameter (bank capital). The banks are grouped same year. For example, one can collect data on
into stratum and were selected using simple total deposits of banks in say 2006. Here the
random sampling supported by judgment variation is across the units, that is different
sampling (non-probability) methods. Our table banks and not for different years, say time. In
above shows that 11 banks (9 banks excluding Time series, data span across time a horizon
non-quoted banks) fall into the frequency of usually on quarterly or yearly basis. An example
bank capital between N25 < N34.9. This means is the total deposits of First Bank from 1986-2006
that 2/3 multiplied 9 gives approximately 6 as could have been used in this study. In this
which were selected from the first stratum. The case the variation is over time. Panel data or
name of nine banks were written on a piece of data set is a technique that combines the features
paper, wrapped and put in a tray from where of both time series and cross section methods.
they were picked. The six out of the nine banks For example, total deposits of banks (one of our
picked are Access bank, Fidelity bank, First explanatory variables) in Nigeria from 1986-2006
Inland bank, Wema bank, Spring bank and as used in this study. Thus, panel data has the
Diamond bank. However, Spring bank was features of time series and cross section.
dropped because the data is only for one year
(that is 2006) and would not be very useful. ESTIMATION, MODEL
Using Judgment sampling an additional bank SPECIFICATION AND DISCUSSION
that is Afribank was selected to complete our
simple random sampling of 2/3 x 9 = 6 in the
OF RESULTS
The ordinary least square method and multiple
first stratum of N25 < N34.9 billion frequency.
regression analysis will be used in estimating
The remaining eight (8) out of the eleven banks
the impact of shareholders funds on
were also selected by writing the names of the
performance of the Nigerian Commercial banks.
30The impact of banking capitalization on the performance of Nigerian banking industry
To test for the significance, reliability and The results of the study on shareholders fund
validity of the result, F- statistic T-statistics, and and bank performance are presented below in
their related probabilities, Coefficient of table 2; buffer theory of capital adequacy as
determination (R2), R bar, Durbin Waston (DW), generated by the computer. Model 1 has
Sum Square Residual (SSE), Standard Error (SE) coefficient of determination (R2) of 0.975 and
of the explanatory variables and coefficient of adjusted (R2) of 0.974. This shows that the
determination R2 are employed. The model will regression has high explanatory power. The
be estimated using annual data and the study values (i.e R2 and adjusted R2) indicate that over
will involve the use of multiple regression 97 percent of the variations in the dependent
technique. Ordinary Least Square (OLS) using variables (shareholders fund) is attributable to
E-View package will be used in presentation of the explanatory variables selected by the model
the result. and include Bank Deposit (BD), bank asset (BA),
From the theoretical perspective, literature bank Loan (BL), Inflation (Infl), Interest (Intr),
review and research questions the following exchange rate, (Exch), Expean (OE) and
hypotheses are postulated to justify our Liquidity (LA). This high goodness of fit is
statement of problem and objectives of study. further supported by the significant F-statistics,
H1: Shareholders fund has significant impact on which is equally high. The implication of this is
banks‟ liquidity, bank loans and growth of bank that the model is well specified and does not
deposits. suffer mis-specification bias. In other words, the
H0: Shareholders fund has no significant impact result from the model can be relied upon in
on banks‟ liquidity, bank loans and growth of making useful deductions with respect to return
bank deposits. on assets. The S.E regression and Durbin-
H1: Operation expenses has significant impact Watson statistics equally lend credence to the
on return on capital. fact that there is no auto correlation. The
H0: Operation expenses has no significant financial implication of this regression will be
impact on return on capital. explained in 4.1 below.
Model 1 is represented as: The results of the study on return on capital and
SHF = f (Bank Deposit, Bank assets, Bank loans, bank performance are presented below in table 3
Infl, Intr, Expeans, Exch, LA, µ) Model 2 is stated as:
……….. ROC = f (Bank deposit, Bank Asset, Bank Loan,
Equation 1 Inflation, Interest, Expean ,Exch, Liquid asset,
Restating the variables in equation 1 in explicit Uit
form, we can represent the model as follows: ………….. Equation 3
SHF = a0 + a1 BD + a2 BA + a3 BL + a4 Infl + ΔIntr Restating the variables in equation 3 in explicit
+ a6 Expean + a7 Exch form, we can represent the model as follows:
+ a8LA + Uit ……………… ROC = a0 + a1 BD + a2 BA + a3 BL + a4 Infl + ΔInr5
Equation 2 + a6 Expean + a7 Exch + a8 LA + Uit
Where the a prori expectation is stated as ………….. Equation 4
δSHF/ δBPM Model 2 has coefficient of determination (R2) of
Where: Expected growth of bank deposits (BD), 0.9978 and adjusted (R2) of 0.9978. This shows
Bank Assets (BA), Bank Loans (BL), that the regression has high explanatory power.
Inflation rate (Inf), interest rate (Intr), The values (i.e R2 and adjusted R2) indicate that
Exchange rate (Exch) and Liquid assets (LA). over 99 percent of the variations in the
Bank Capitalization (SHF) is expected to be dependent variables (return on capital) is
positively related to bank loan. Bank attributable to the explanatory variables selected
performance indices such as bank assets, bank by the model and include Bank Deposit (BD),
deposits, liquid assets and bank loan (BA, BD, bank asset (BA), bank Loan (BL), Inflation (Infl),
LA, and BL) should have a positive relationship Interest (Intr), exchange rate, (Exch), Expean
with Shareholders Fund. (OE) and Liquidity (LA). This high goodness of
This is represented in equation form as: δSHF/ fit is further supported by the significant F-
δBPM > 0 statistics, which is equally high. The implication
of this is that the model is well specified and
31The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
does not suffer mis-specification bias. In other Foreign exchange (forex) pricing mechanism (s)
words, the result from the model can be relied over the years has been an important
upon in making useful deductions with respect macroeconomic variable in an open economy
to return on assets. The S.E regression and such as Nigeria. In an open economy we expect
Durbin-Watson statistics equally lend credence a flourishing banking sector now awash with
to the fact that there is no auto correlation. The capital fund to affect the external sector.
financial implications of this regression will be Borrowing for the purchase of machines and
further explained in 4.1 that is result of raw materials from abroad should be expected
hypotheses. as banks make more demand for forex at the
Insert table-2 and 3 here periodic bidding using the Dutch Auction
The studies of bank capitalization and System (DAS). This will only drive up the
performance enables us provide answer to exchange rate, causing the Naira to depreciate,
questions of macroeconomic variables such as posing an inverse relationship, and very little or
(interest rate, exchange rate and inflation); if no statistical significance. Interest rate and
inadequate capital affects the Nigerian banks to return on capital share a negative relationship,
compete effectively in the international market thus as interest rate rises, return on capital
and play their major role of financing economic decreased during the period covered by this
activities. It also provides answer to the study. However, historically, we know that even
soundness, safety, profitability, quality of loan when prime interest rate was falling it made no
portfolio, asset, and deposit in the Nigerian significant impact on the economy. Banks have
banking industry. The selection of bank not made concerted effort to transmit to the
management has not been taken seriously and economy the benefit of lower interest rate. In the
the performance is a function of the inputs. The past excess money balances will normally go for
study also provides answer to the impact of cost purchase of foreign exchange from the CBN
of operation on bank capital. Our auction market for a premium in the foreign
macroeconomic variables of interest rate, exchange parallel market. In this new era of
inflation and exchange rates have had no mega banks, we expect bank management to
significant effect on Return on Capital have another look at their interest rate policy
(ROC).This is represented in model 2 of this such that it will re-engineer and stimulate the
study. Thus, it means that macro economic growth of the economy. Inflation rate possesses
variables that is interest rate, inflation and an inverse relationship to return on capital, thus
exchange rates have not led to significant as inflation rises, return on capital during the
change on Return on Capital (ROC) one of the period covered by the study falls. This conforms
indicators of bank capitalization. Inflation rate, to a priori expectation. Where the economy is
interest rate and exchange rate have negative resting at a sub-optimal level, it requires
association with return on capital. This implies government‟s fiscal policy or perhaps any
that return on capital and inflation rate, interest external shock, a change in expectation (output)
rate and exchange rate move in opposite etc to boost aggregate demand and
direction. The coefficient points to the fact a subsequently aggregate supply. An important
percentage increase of these macroeconomic tool to stem the tide of rising inflation in Nigeria
variables will lead to about 66.2 in exchange is massive expenditure in infrastructure
rate, 163. 0 inflation rate and 761.4 interest rate development.
decrease in return on capital. As reported by Ige
(2006) recent studies incorporating these DISCUSSION OF HYPOTHESES
variables indicated they could be statistically Going to specifics and testing the stated
significant since they are more often than not at hypotheses in our model which captures the
the mercy of the free market and not by buffer theory of capital adequacy, the result in
government fiat. This does not conform to our a the table 2 indicate that the hypothesis with null
priori expectation that capitalization will be that there is no significant relationship between
affected positively by interest rate, inflation and shareholders‟ fund and bank‟s liquidity is
exchange rate. rejected at 1 percent level of significance. This is
32The impact of banking capitalization on the performance of Nigerian banking industry
because the probability value is far less than about 0.254 increase in the level of shareholders‟
0.01. Thus, the alternative hypothesis that there fund. This conforms to theory that loans and
is a significant relationship between advances represent the highest incomes item for
shareholders‟ fund and banks‟ liquidity is banks. This also conforms to literature, that is,
substantiated. This implies that banks the higher the loans and advances portfolio the
capitalization (shareholders fund) and banks‟ higher the shareholders‟ fund. However, this is
liquidity move in opposite direction as reflected subject to recovery of the loans and advances.
by the negative sign. This conforms to a priori The core business of banking which is credit
expectation that bank shareholders‟ fund is involves financial intermediation manifested in
affected positively by bank liquidity. This the mobilization of deposit from the surpluses
implies that bank capitalization requirement is units and the passing on the funds sourced to
very significant to bank health. In capital the deficits (needed) units accordingly. The
structure theory all equity firms are deposit is mobilized at a cost to the bank and
characterized by greater liquidity positions than this cost is often called interest. On the other
levered firms and would embrace equity to hand, it is passed to the users who also pay
finance real investment with positive net present interest though at a higher rates than the deposit
value. However, banks use a mix of debt but rate. This presupposes that a bank must ensure
more of equity in their equity financing to avoid proper management of its asset and liabilities,
seizure of the assets by creditors in the event of both in composition and utilization. Against the
bankruptcy. backdrop of the present competitive banking
However, the nature of the results may not environment, the intermediation theory
precisely explain the situation in Nigeria context therefore requires that banks need to mobilize
because there are other real issues that needs to funds from the customers by engaging in
be explained. A good explanation may be found aggressive marketing of financial services. This
with management expertise, which presupposes is very crucial for sustainability of banking
that high capital requirement may not make business in this era of keen competition.
significant impact to bank‟s liquidity and by Another sub hypothesis one was also tested
extension profitability, if qualitative using the result in (table 2) and help to reject the
management is not in place to ensure effective null hypothesis of no significant relationship
and rewarding utilization of additional capital between bank capitalization based on the use of
introduced. In other words a bank without good shareholders fund and bank deposit in favour
management, accountability and good of the alternative hypothesis. In addition, the
governance culture may worsen the position it negative sign indicates that they move in
was before the injection of new funds. Hence, opposite direct. The coefficient points to the fact
the use of regulatory tools by CBN to check that a unit increase of bank‟s deposit will lead to
illiquidity in the Nigerian banking industry. The about 0.156 decrease in shareholders‟ fund. This
period of 1990‟s and earlier 2000 in the Nigerian is contrary to our a priori expectation that
Banking Industry witnessed high rate of bank capitalization based on the use of shareholders
distress due to banks having reduction of the fund will positively influence bank deposit.
capital base which affected their liquidity ratio – According to the expense theory, Nyong (2001)
ability to meet short term obligations of opined that managers have the option in
customers as they became due. pursuing policies, which maximize their own
Another sub hypothesis was tested using the utility rather than profit maximization for
result in (table 2). From the result, the null shareholders. Where managers prefer prestige,
hypothesis of no significant relationship wrong loan application, power and status, it
between shareholders fund (SHF) and bank would be reflected in the amount of slack they
loans (BL) is rejected, which means that the receive in form of expense account, luxurious
alternative hypothesis that states a significant offices and building, company cars and other
relationship between shareholders‟ fund (SHF) perquisites of office. This was the situation that
and bank loan (BL) is accepted. The result led to the spate of bank distress in Nigerian
equally shows a positive relationship between banking Industry in the late 1980‟s, mid-1990
shareholders fund and bank loans. In other and early 2000.
words, a unit increase in bank loans will create
33The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
The relevant result containing hypothesis 2 this study refers to a number of variables of
(two) are in table 3 in which return on capital interest which are produced from the existence
(ROC) as reflected by profitability is stated as of funds for use in the process of intermediation.
the dependent variable. This is represented in From these funds, obviously concepts such as
model 2 of the study. The result shows that the Return on Capital (ROC) and Shareholders Fund
null hypothesis of no significant relationship (SHF) are derivatives from the use of funds. In
between managerial efficiency and return of this research, SHF and ROC represent our
capital cannot be rejected at 10 percent level of dependent variables whereas our controlled
significance. This is because the probability independent variables are: bank assets, bank
value of 0.171 is greater than 0.10. Thus, the deposits, bank loan, liquid assets, operating
operating efficiency, though it is positively expenses, macroeconomic variables such interest
related to return on capital, its impact is not rate, exchange rate and inflation. Availability of
significant in its influence. This does not funds facilitates return on capital. Further, the
conform to a priori expectation that efficiency of crux of this study is to see how bank
bank management measured by operating capitalization in Nigeria make fund available for
expenses is expected to be negatively related to realization of adequacy of capitalization and
ROC. performance.
Wrong signs and/or significance or non-
significance of the parameters does not Implications of Findings
necessarily imply that violation of a priori The analyses on table 2 shows the null
expectations is tantamount to poor empirical hypothesis of no significant relationship
result. Rather one is led to ask the ultimate between managerial efficiency and return on
question whether in posterior and a priori capital cannot be rejected at 10 percent level of
expectations Nigerian commercial banks can be significance. Thus, the operating efficiency,
expected to utilize bank capital to the ends though it is positively related to return on
required by the shareholders and the economy. capital, its impact is not significant in its
The real issue in Nigeria case has been that of influence. Perhaps the energy crisis in the
mismanagement of funds which is aptly Nigerian nation has had effect on adequacy of
explained by our expense theory. A good bank capital and consequently performance of
explanation may be found with management banks. Operational expenses affected by
expertise, which presupposes that high capital absence of electricity, access roads has affected
requirement as stipulated by the buffer theory of banking performance e.g overall profitability
capital adequacy may not curtail reckless tough the impact is not too significant. The
spending by managers who may indulge in positive and insignificant coefficient in our
reckless spending of bank capital. In other operating expenses, instead, suggests that banks
words a bank without good management may are able to pass on most of the high overhead
worsen the position it was before the injection of costs to customers through higher spreads in
new funds. In the Pre and Post consolidation era order to keep profits unaffected. To the extent
in Nigerian banking industry what we have that banks‟ ability to overcharge is a function of
seen is bank management establishing more their market power, this outcome presents
bogus bank branches everywhere rather using evidence of market power incidence in the
bank capital for worthwhile projects that will banking sector.
enhance shareholder wealth and the economy. Because of the rising cost of doing business the
tendency is that interest rate on lending might
SUMMARY, FINDINGS AND continue to rise except it is controlled by
RECOMMENDATIONS government. We also find that there is
Summary of Findings significant relationship between shareholders‟
This study has attempted to find the fund and banks‟ liquidity, bank deposits, and
relationship between bank capitalization and bank loans. This also conform to a priori
performance in the Nigerian banking industry expectation that bank capitalization will be
specifically commercial banks. Capitalization in affected positively by bank liquidity, bank
34The impact of banking capitalization on the performance of Nigerian banking industry
deposits and bank loans. The efficiency of and sequential growth phase
management measured by operating expenses through the ranks as some of the
indice is negatively related to return on capital. imperatives.
Inflation rate, interest rate and exchange rate (ii) Shareholders fund and total assets of
have negative association with return on capital. the bank should be periodically
This implies that return on capital and inflation evaluated.
rate, interest rate and exchange rate move in The regulatory authorities will need
opposite direction. Macroeconomic policies are to put in place appropriate
important. Inflation reduces credit expansion by machinery or tool that will address
contributing to higher interest margins. issues of bank liquidity and shore
Therefore, policies aimed at controlling inflation assets quality in the industry. Bank
should be given priority in fostering financial management in conjunction with
intermediation. Fiscal and monetary policies the regulatory authorities should at
designed to promote output stability and all times address causes of
sustainable growth is good for financial illiquidity rather than the systems.
intermediation. In this way, lost confidence can once
When bank loans are profitably employed it will again be restored in the Nigerian
definitely lead to increase in profit and banking industry. It is important to
consequently shareholders fund. When banks carry routine checks, periodic
are able to influence the other sectors in the examinations on bank returns.
economy through extension of loans, it would (iii) We strongly suggest that apart from
lead to multiplier effect in the long run, reduce capital, technology, customer care,
inflation and appreciate the naira. Bank capital aggressive marketing and efficient
cannot on its own influence bank deposit as service delivery are tools that can be
depicted by our result. There is no doubt that used to attract more customers to
the days of armchair banking are over and shore up bank deposit. This will
intense competition in the Nigerian banking also help to reduce market
industry has come to stay. On the basis of the concentration and also break the
empirical findings of this study, and considering monopoly power of the big banks.
the fact that the days of armchair banking has (iv) Where there exists a viable financial
been overtaken with the intense competition in infrastructures, bank management
the Nigerian banking industry, we recommend should lobby governments for the
the following: provision of an enabling
Recommendations environment for banks to strive.
(i) A bank without good management This will help to minimize the
(input) may worsen the position it operation expenses (OE) of the
was before the injection of new banks.
funds. Where managers prefer (v) Bank returns are affected by
prestige, power and status, it would macroeconomic variables,
be reflected in the amount they suggesting that macroeconomic
receive in form of expense account policies that promote low inflation
and luxurious. Management rate, stable exchange rate, low
capability should be better interest rate and output growth will
supported, for the best of assets can boost credit expansion. Government
be overturned in short period by should provide an enabling
management. It is a known fact that environment and also control
CBN plays an important role in the interest rate on credit in the short
selection of bank executives at the term to enable customers such as
directorate level. The policy for the corporate bodies, manufacturers,
selection of this class of bank and industrialists obtain loans in
workers should emphasize strict order to stimulate economic growth.
consideration of good track records (vi) The study identified a positive
relationship between shareholders
35The Journal of Commerce, Vol. 4, No. 1,
ISSN: 2218-8118, 2220-6043
Hailey College of Commerce, University of the Punjab, PAKISTAN
fund and bank loan. The higher the Company-Level Evidence
loans and advances, the higher the from Nigeria,” Second Annual
bank income; provided the credit Conference, the Department of Finance,
facilities are recovered. In order to University of Lagos, pp 1-6.
sustain this relationship, bank
management should strengthen Ajekigbe, Jacobs. M (2009): “The Nigerian
their supervisory units in credit Banking Industry: Challenges and
administration, that is, from loan Prospects (1977-2008)”, Being a Text
application to drawdown of such Valedictory Lecture Presented at Muson
facilities so as to avoid bad loans in Centre, Onikan, Lagos on Tuesday 13
its financial statement. January, 2009, Organized by the
(vii) For Nigerian banks to be major Chartered Institute of Bankers of Nigeria.
players in domestic and Annual and Financial Reports of Banks (Various
international financial market, its issues)
capital must be kept above the Athanasoglou, P.P; Brissimis, S.N and Delis,
minimum regulatory requirement at M.D (2005): Bank-Specific, Industry
all times. Specific and Macroeconomic
(viii) Central Bank of Nigeria should Determinants of Bank Profitability, Bank
ensure that bank Greece Working Paper, No.25. Pp. 1-10.
management/managers apply Athanasoglou P., Delis M, and C. Staikouras
customers deposit for worthwhile (2006): “Determinants of Banking
projects instead of using such for Profitability in the Southern Eastern
prefer prestige, wrong loan European Region”, Bank of Greece
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