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.
Highlights
Capital Adequacy Ratio (CAR) is one of the fundamental measures of the strength and wellness of banks the world over
The overall conclusion of the study is that Capital Adequacy Ratio is largely determined by banks risk-portfolio, deposit level, profitability and asset quality and that while risk level, deposits level and profitability are positively related to CAR, Asset Quality Ratio (AQR) is negatively related to Capital Adequacy Ratio
The following recommendations are for deposit money banks: a) Since the study reveals that profitability is the major and most important determinant of CAR and profitability is a major variable in the Basel Accord capital adequacy computation model, Nigerian deposit money banks should increase their reserves accounts in order to enhance their capital adequacy position and the overall safety and soundness of the entire banking system through better operational results and more prudent management of their available resources
Summary
Capital Adequacy Ratio (CAR) is one of the fundamental measures of the strength and wellness of banks the world over. The Basel Committee on Banking Supervision handed down the first Basel Accord in 1988 which is the popularly referred to as Basel I. This marked a significant milestone in the governance of the global financial system as it focused on defining regulatory capital, measuring risk-weighted assets, and setting minimum acceptable levels for regulatory capital [2]. Basel I and Basel II fixes minimum Capital Adequacy Ratio at 8% while in 2010, the world’s central bankers, represented collectively by the Bank of International Settlements (BIS) handed down Basel III which hiked Capital Adequacy Ratio requirement from 8% to at least 10.5% of a bank’s risk-weighted assets [3]
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