Obadimu and Oboh (2024) CJBSS (2024), 15(1), 21-37

Covenant Journal of Business & Social Sciences (CJBSS) Vol. 15. No.1, June 2024
-
ISSN: p. 2006- 0300 e. 2334-5708 DOI: XXX

An Open Access Journal Available Online

Impact of Banking Regulation and Supervision on the Financial Performance of Listed

Deposit Money Banks in Nigeria

OBADIMU Gafar Akolawole

Department of Accounting, University of Lagos;
obadimugafar22@[Link]; 23487039610971

OBOH Collins Sankay

Department of Accounting, University of Lagos;
coboh@[Link]; 2348069561340

Received: 22.5.2024 Accepted: 24.6.2024

Date of Publication: June 2024

ABSTRACT
This study aims to provide empirical evidence that reveals how the regulation and supervision of the
Central Bank of Nigeria (CBN) affect the financial performance of deposit money banks (DMBs).
Specifically, the study examines the impact of the capital adequacy ratio (CAR), loan-to-deposit ratio
(LDR), and asset quality ratio (AQR) on the financial performance of DMBs in Nigeria. The study
obtained data from the annual reports and accounts of ten DMBS purposefully selected, covering a period
of 2011 – 2020. The data were analyzed using an estimated generalized least square (EGLS) two-way
random-effects panel regression analysis. The results suggest that, to a large extent, the sampled DMBs
complied with the CBN requirements on CAR, LDR, and AQR. The study found that LDR positively
impacted the financial performance of the DMBs, while the impact of CAR and AQR on the financial
performance of the DMBs was insignificant. The study recommends that while DMBs pursue their profit-
making objective, they should comply with the regulatory and supervisory guidelines of the CBN to avoid
regulatory fines and penalties.
Keywords: Asset quality ratio, Banking, Capital adequacy ratio, Loan-to-deposit ratio, Profitability

1. Introduction
Financial institutions, particularly banks, are essential to the economic growth of a nation
(Mbatabbey, 2019). They mobilize idle funds from surplus units (savers) to deficit spending units
(borrowers) and facilitate savings and investments through financial intermediation (Ikpesu &
Oke, 2022). They maintain national banking stability and foster global commerce through
intercontinental banking (Udeh, 2015). Though the banks are pivotal in aiding financial
prosperity and economic growth, they are highly regulated by the apex bank of a country due to
perceived risks associated with the industry and to promote and maintain trust and goodwill
between the banks and the public. At the global level, international laws, to a great extent,
regulate banking activities. For example, in 1987, the Basel Committee of Banking Supervision
(BCBS) established the Basel I Accord to promote uniform capital standards in the banking sector
across nations and to manage and regulate credit risk in member countries. Basel II was
introduced in 2004 to regulate banking capital and to capture market and operational risks, while

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Basel III, introduced in 2010, emphasizes the quality and transparency of the capital base of banks
in member countries (Mehta & Bhavani, 2017).

In Nigeria, the Central Bank of Nigeria (CBN) Act 2007 empowers the CBN to regulate and
oversee the affairs of the banking industry. The Act authorizes the CBN to develop and administer
guidelines and policies and to perform supervisory and control functions on banks in Nigeria
(Ennis & Walter, 2016; Mbatabbey, 2019). The Act mandates the CBN to set the banking policies
of deposit money banks (DMBs), which they must follow to maintain stability, safety, and
confidence in the industry. Also, to reduce risks and ensure minimal resources to meet the
liquidity needs of customers, DMBs are required by the CBN to maintain a level of capital
adequacy, lower-level non-performing loans, and limit the volume of customers’ loans to their
total deposits (Disalvo & Johnston, 2017). In 2013, the CBN announced that all DMBs must
implement and maintain a capital adequacy ratio (CAR) of 10% for regional/national banks and
15% for banks licensed to operate internationally and to maintain a minimum loan-to-deposit
ratio (LDR) of 65% and retain a maximum of 5% non-performing loan ratio, which are meant to
encourage small and medium-scale enterprises (SMEs) and improve lending (Thi, 2020; Obioma
& Charles, 2018).

Though the regulations and guidelines of the CBN are well-intended, they limit the profit-making
drive of DMBs (Abba, Okwa, Soje, & Aikpitanyi, 2018; Abata, 2014; Tuškan & Stojanović,
2016). According to Abba et al. (2018), profit-making is the primary objective of the DMBs,
which they earn from loans and advances. But the regulations of the CBN on LDR, interest rate,
and other oversight functions cap the operation and profit-making objective of the DMBs
(Akinjobi, 2022; Aldhaheri & Nobanee, 2020; Obateru, 2021; Obioma & Charles, 2018).
Previous studies suggest that the regulations and oversight policies of the CBN impact the
profitability of DMBs, which directly or indirectly impact the economy (Olabisi, 2021; Trefis,
2016). The failure of many DMBs between 2009 and 2012 is believed by some scholars to be
occasioned by poor management of their loan assets in line with the guidelines and regulations
of the CBN. Besides, some DMBs make irregular provisions and use different impairment
assumptions to manage their loan assets to meet the regulatory requirements of the CBN and
remain in business (Thi, 2020).

Reflecting on the liquidity challenges DMBs face in complying with the CBN regulations at the
expense of their core motive of profit making, it becomes necessary to investigate the impact of
the regulatory and supervisory roles of the CBN on the financial performance of DMBs because,
as Nwanna and Odia (2018) observed, too many regulations limit the operations and extent to
which DMBs can maximize shareholders' wealth and stay competitive in the financial market.
Besides, many DMBs struggle to comply with the many regulations and guidelines of the CBN,
some of which have been the cause of conflicts between the DMBs and their customers. A classic
example of how banking regulations and policies can affect the operations and possibly
profitability of DMBs is the recent fallout of the naira redesign policy of the CBN, where DMBs
were mandated to implement the directives of the CBN on the stoppage of the old naira notes,
which led to the destruction of properties and harassment of bank officials by angry customers.
Though some scholars disagree with the dictatorial regulations of the CBN (Abba et al., 2018),
some believe the CBN must regulate the operations of DMBs to ensure financial soundness and

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stability to protect depositor's funds and ensure an effective and efficient banking system that can
compete with its sphere in the globe (Ikpesu & Oke, 2022).

Considering the importance of capitalization decisions and the oversight functions of the apex
bank to the success of the banking industry of a country (Akinjobi, 2022; Olabisi, 2021; Singhal
et al., 2022), the current study is undertaken to shed light on the possible effects of the regulations
and supervision of the CBN on the financial performance of DMBs. Specifically, the study adds
to the small stock of literature on banking regulations within a developing country context by
investigating the impact of capital adequacy ratio (CAR), loan-to-deposit ratio (LDR), and asset
quality ratio (AQR) on the financial performance of DMBs in Nigeria. Previous research suggests
that capital adequacy and asset quality are necessary for the survival of DMBs and to assess their
ability to cover operational expenses, meet customers' withdrawal needs and protect depositors
against loss in the event of financial distress (Onuh, 2002; Ikpesu & Oke, 2022), but some
scholars are in doubt of the effect of the overbearing oversight functions of the CBN on the
financial performance of DMBs (Nwanna & Odia, 2018; Olabisi, 2021).

Thus, the current study adds to the growing literature on banking regulations and provides new
information to promote sustainable banking guidelines in Nigeria and other developing countries.
Also, the findings will serve as a benchmark for future research on banking regulations in other
developing countries. The other parts of the study are arranged as follows: section two presents
the theoretical background and hypotheses development. Section three discusses the
methodology adopted for the study. The results are presented in section four and the findings are
discussed in section five. The conclusion and implication are presented in section six, while
section seven discusses the limitations and suggestion for future studies.

2. Theoretical Background

This study employs the liquidity preference theory (Keynes, 1936) and capital adequacy theory
(Berger & DeYoung, 1997) as complementary means of examining the impact of banking
regulations and supervision on the financial performance of DMBs.

In 1936, John Maynard Keynes introduced the liquidity preference theory as a novel way of
understanding the connection between interest rates and the supply-demand of liquidity. The
theory asserts that holding liquid assets is desirable to expedite transactions, act prudently, and
take advantage of investment opportunities in the financial market (Lavoie & Reissl, 2019; Ugwu
et al., 2020). Keynes notes that focusing on interest rates alone as a reward for saving is improper
(that is, the interest rate is not the motive) because a person can hoard his savings in cash in a
piggy bank without any interest and yet would have refrained from consuming all his current and
available income (Culham, 2020; Keynes, 1936; Ugwu et al., 2020). Liquidity in the context of
Keynes (1936) is based not on the demand for money or the most tradable asset but on price-
protected (capital-safe) assets, most directly inside and outside money (Culham, 2020). The
theory assumes that the public is willing to forgo interest income for short-term price-protected
assets due to capital and price uncertainties associated with market liquidity. It holds that the
interest rate is a monetary phenomenon determined independently of saving and investment
(Bonizzi & Kaltenbrunner, 2020; Culham, 2020; Keynes, 1936).

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In keeping with the liquidity preference theory, this study holds that DMBs enable clients to
access liquid cash for transactional, speculative, and preventative objectives, and the capacity to
generate credit and increase liquidity boosts the competitive position of DMBs (Sugeng, 2018).
The study expects DMBS to understand the rationales for tying down liquid capital and the
implications on their profitability. And since the CBN regulates the liquidity position, capital
requirement and LDR of DMBs, they must consider that low liquidity jeopardizes their ability to
meet the liquidity requirements of their clients (Thi, 2020). Though excess liquidity may expose
DMBs to fraud risk, being liquid helps them deal with and survive financial difficulties (Godwin
& Comfort, 2015). On account of the liquidity preference theory, this study argues that though
the CBN regulations may aim to promote a sound financial system with sufficient liquid assets,
they may limit the profit-making drive of DMBs. Thus, with the CBN liquidity regulations,
DMBs must consider the risks of low or excess liquidity and the effects on their profitability.

The capital adequacy theory is also a valuable theoretical lens through which to assess the impact
of bank regulations on the profitability of DMBs. The theory requires DMBs to have certain
assets, which can be shifted to the central bank when liquidity needs arise (Aliyu, Abdullyhi, &
Bakare, 2020). Therefore, compliance with regulatory requirements may affect the financial
performance of DMBs (Milne & Wiley, 2001; Simeneh, 2020; Sugeng, 2018). In keeping with
the capital adequacy theory, this study assumes that holding large capital allows DMBs to explore
future investment opportunities, boost performance, and avoid regulatory penalties (Berger &
DeYoung, 1997). Therefore, it is expected that DMBs would increase their capital to avoid
compliance penalties by the regulators when their CAR falls below the required ratio (Ezike &
Oke, 2013; Ikpesu & Oke, 2022; Sugeng, 2018). As noted by Simeneh (2020), during the
financial crisis, banks with low capital may increase systemic risk and undermine financial
stability, which could prompt the regulators to modify the capital requirements. Hence,
complying with the required minimum capital and keeping excess capital will reduce the
likelihood of bank capital falling during a general economic or financial crisis (Ugwu et al.,
2020). Akin to the capital adequacy theory, this study expects an association between the CBN
regulation on capital adequacy and the financial performance of DMBs.

2.1 Hypotheses Development

Capital adequacy ratio and financial performance

The capital adequacy ratio (CAR) is an important parameter used by the apex bank of a country
to measure and regulate the capital adequacy of banks operating in the country. In Nigeria, in line
with the Basel Accord guidelines and recommendations of the BCBS, the CBN requires DMBs
to increase and maintain a certain level of capital adequacy to ensure stability in the banking
industry (Asikhia & Sokefun, 2013; Ikpesu & Oke, 2022). However, when a bank cannot meet
the specified capital adequacy level, it would be required to reduce its loan assets (Abba et al.,
2018; Leila, Hamidreza & Farshid, 2014). But reducing the loan assets of DMBs may affect their
profitability negatively since they earn interest income from their loan assets (Abba et al., 2018;
Aldhaheri & Nobanee, 2020). Previously, Abdul (2017) argued that adequate capital directly and
automatically influences the amount of funds available for loans, which invariably affects the
level and degree of risk DMBs can absorb. Following Abdul's (2017) submission on
capitalization, Aliyu, Abdullyhi, and Bakare (2020) and Ikpesu and Oke (2022) found a positive

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association between capital adequacy and profitability, indicating that capital adequacy could
invariably translate to improved earnings and performance of DMBs. However, an earlier study
by Onaolapo and Olufemi (2012) reported an adverse effect of capital adequacy on profitability.
In a comparative study on the interrelationship between capitalization and profitability in the
banking sector of BRICS countries, Singhal et al. (2022) reported that capitalization has a
detrimental effect on profitability in China and South Africa when considered in light of the
agency theory and not in Brazil, Russia, and India when considered in light of the signalling and
bankruptcy cost hypotheses. Theoretically, many scholars regard capital adequacy as a significant
factor in fostering risk management efficiency. However, there is no consensus in the literature
on its effect on the financial performance of DMBs. Therefore, there is a need to provide further
insight into the ongoing capitalization-profitability debate. In light of previous empirical
literature and the theoretical discussion on capital adequacy, this study hypothesizes that:
H1: CAR and the financial performance of DMBs are positively associated.

Loan-to-deposit ratio and financial performance

The loan-to-deposit ratio (LDR) is another significant measure used by central banks of countries
to assess the liquidity position and associated risks of DMBs and their ability to meet the liquidity
needs of depositors (Iwedi, 2017; Trefis, 2016). It indicates the capacity of the banks to meet
customers' cash demands with minimal or no loss. As earlier argued, banks make credit facilities
available to borrowers from depositors’ funds to earn interest income (Ikpesu & Oke, 2022).
Previous research suggests that DMBs give more credit facilities to investors from whom they
can get a high-interest income, not minding the associated risks (Aldhaheri & Nobanee, 2020;
Ennis & Walter, 2016). But to keep depositors' funds safe and reduce the risk of illiquidity, central
banks of many countries determine and regulate the LDR of banks. In Nigeria, the CBN requires
DMBs to maintain a minimum LDR of about 65% (Obioma & Charles, 2018) and to make more
credit facilities available to the real sector and small businesses at a regulated interest rate
determined by the CBN. Though some economic experts argue that higher credit facilities could
translate to higher profitability (Ikpesu & Oke, 2022), critics believe higher credit facilities
expose DMBs to illiquidity risks, not having enough liquid resources to cover unforeseen fund
requirements, which could invariably affect their financial performance adversely. Hitherto, the
association between LDR and profitability has remained controversial among economic experts.
For example, Hadian (2021) reported that LDR has a positive effect on profitability, which
contrasts the negative impact on profitability documented by Ajayi and Lawal (2021) and Suroso
(2022) and the insignificant effect reported by Anggari and Dana (2020) and Saleh and Winarso
(2021). Based on previous literature and the theoretical discussion on liquidity preference, the
current study intends to provide further insight into the possible interaction between LDR and
profitability by hypothesizing that:
H2: LDR and the financial performance of DMBs are positively associated.

Asset quality ratio and financial performance

Besides having adequate capital, asset quality is essential for survival since asset quality involves
the examination of the bank asset in a bid to ascertain the size and level of credit risk linked with
its activities (Ikpesu & Oke, 2022). Regulators are concerned about the asset quality of DMBs
since a weak asset quality not only affects profitability and operations but also affects the

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financial stability of the economy (Ikpesu & Oke, 2022; Richard & Prakash, 2019). Unlike non-
financial companies, where loans are regarded as liabilities, bank loans to customers are
categorized as loan assets. The interest earned on loan assets forms a significant part of the
income of DMBs, referred to as interest income. But while DMBs may aim at giving out more
loans, they are confronted with the risk of default and failure of borrowers to pay back the loans
(Rostami, 2015). According to Trefis (2016) and Obioma and Charles (2018), when the credit
risk of a DMB increases, its loan quality or asset quality deteriorates due to upward movement
in the ratio of non-performing loans. Accordingly, a decreasing asset quality compels DMBs to
hold more capital and make provisions for losses (Rostami, 2015). Previous literature suggests
that a low liquidity ratio and even poor asset quality could lead to the failure of DMBs (Mehta &
Bhavani, 2017). For example, between 2009 and 2010, many DMBs in Nigeria failed due to poor
asset quality management, high non-performing loans and insider lending (Obioma & Charles,
2018; Udeh, 2015). Though previous studies suggest a strong correlation between AQR and
financial performance, Trefis (2016) argues that since the activities of DMBs are now diversified,
asset quality alone should not be a key determinant of their financial performance. However,
because of the need to remain in business and to meet regulatory requirements, some bank
managers make irregular provisions and use different impairment models to manage the quality
of their loan assets to conform with the regulatory guidelines (Kyari, 2015; Lucky & Nwosi, 2015;
Obioma & Charles, 2018). Considering the possible interaction between AQR and profitability,
as previous literature suggests, the current study provides further insight into the ongoing debate
on the effect of AQR on the financial performance of DMBs. Thus, the study hypothesizes that:

H3: AQR and the financial performance of DMBs are positively associated.

3. Research Methods and Data

3.1 Design, Sample and Procedure

This study adopts the panel analysis designs to examine the impact of banking regulations on
capital adequacy ratio (CAR), loan-to-deposit ratio (LDR), and asset quality ratio (AQR) on the
financial performance of DMBs in Nigeria. As of January 2022, when this study was conducted,
there were fourteen (14) DMBs listed on the Nigeria Exchange Group (Nigeria Exchange Group,
2022). However, using purposive sampling, the study excluded DMBs with incomplete annual
reports for the period (2011 – 2020), reducing the sample to ten (10) DMBs with 100
observations. The study constructed a panel dataset from the publicly available annual reports of
the sampled DMBs for ten years (2011 – 2020).

3.2 Operationalisation and Measurement of Variables

This study operationally defines its variables into two - the dependent and independent variables.
The dependent variable is the financial performance of the DMBs, measured using return on
assets (ROA), the value of net profit after tax divided by the total assets (Leila et al., 2014). It
indicates how efficiently a bank uses its assets to generate income (Petersen & Schoeman, 2008).
The independent variables are capital adequacy ratio (CAR), loan-to-deposit ratio (LDR) and
asset quality ratio (AQR), proxies of banking regulation and supervision. CAR is the total capital
of a bank to its risk-weighted assets (Abba, Zachariah, & Inyang, 2013). LDR is the year-end
total loans divided by the year-end total deposits (Obioma & Charles, 2018), and AQR is the
value of non-performing loans (NPL) divided by the gross value of the loan in a given period.

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AQR assesses the risk associated with the loan and investment assets of DMBs (Abba et al., 2018;
Iwedi, 2017; Mbatabbey, 2019). When it is low, the quality of loan assets increases and when it
is high, the quality of loan assets decreases.

3.3 Model Specification and Data Analysis

The following regression model is estimated to test the three hypotheses of the study using an
estimated generalized least square (EGLS) (two-way random-effects) panel regression method:

FINPERFit = β0 + β1CARit + β2LDRit + β3AQRit + εit

Where FINPERFit is the financial performance of bank i at period t. It is the dependent variable,
measured as return on assets (ROA). CARit is the capital adequacy ratio of bank i at period t,
LDRit is the loan-to-deposit ratio of bank i at period t, AQRit is the asset quality ratio of bank i at
period t, and ε is the error term. The study conducted a descriptive statistical analysis and
performed a Pearson correlation to examine the association between the dependent and
independent variables and to check for multicollinearity concerns among the independent
variables to further augment the Durbin-Watson test of autocorrelation between the errors (Field,
2009; Alshatti, 2015). The study employed the Swamy and Arora estimator of component
variances (EGLS - two-way random-effects) to estimate the regression model and test the
hypotheses developed for the study. All the analyses were performed using the Eviews statistical
analysis software version 9.

4. Analysis and Results

4.1 Descriptive Statistics

This study computed the mean, standard deviation, Skewness, and Kurtosis distributions for the
dependent and independent variables. To account for the Skewness of the distribution, a right-
tailed position suggests a positively skewed distribution, while a left-tailed indicates a negatively
skewed distribution. The Kurtosis statistic is either flatter or substantial peak distributions. Table
1 reports the results of the analysis.

Table 1: Descriptive Statistics

FINPERF CAR LDR AQR
Mean 0.0140 14.264 0.6375 4.5444
Median 0.0131 18.175 0.6223 3.7700
Maximum 0.0613 30.000 0.9916 35.240
Minimum -0.0788 -201.59 0.0832 0.0001
Std. Dev. 0.0196 26.011 0.1749 4.2026
Skewness -1.2046 -6.7205 -0.2078 4.8134
Kurtosis 8.8062 52.454 3.0442 32.408

Jarque-Bera 164.6497 10943.05 0.7276 3989.60

Probability 0 0 0.6950 0
Sum 1.3969 1426.42 63.751 454.437
Sum Sq. Dev. 0.0382 66980.33 3.0276 1748.48
Observations 100 100 100 100
Source: Authors’ computation with the aid of Eviews 9 (2023)
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As presented in Table 1, the mean score (0.0140) for FINPERF indicates low profitability across
the sampled DMBs compared to the minimum value of -0.0788 and maximum value of 0.0613,
having a left-tailed Skewness (-1.2046) with a substantial peak value of 8.8062. The standard
deviation (1.96) indicates a slight variation in the ROA of the sampled DMBs. Also, the mean
score (14.264) for CAR suggests that the CAR of the DMBs is moderately higher than the CBN
minimum requirement (10%) for regional/national banks and a little less than the 15%
requirement for DMBs licensed to operate internationally. While this variable is Skewed toward
the left (-6.7205) and has a substantial peak value of 52.454, the minimum value is -201.59, while
the maximum value is 30.00. The standard deviation (26.01) compared to the mean indicates a
moderate variation in the CAR of the sampled DMBs. The mean score (0.6375) for LDR indicates
that the LDR of the DMBs for the period is a little less than the 65% minimum requirement of
the CBN. The minimum value is 0.0832 and the maximum value is 0.9916. This variable is
Skewed toward the left (-0.2078) and has an average peak value of 3.0442. The average of
63.75% suggests that DMBs in Nigeria are progressing toward the minimum LDR requirement
of the CBN (Mbatabbey, 2019). The standard deviation (0.1749) compared to the mean indicates
a high variation in the LDR of the sampled DMBs. Lastly, the mean score (4.5444) for AQR
indicates that the AQR of the DMBs is about the limit of 5% for non-performing loans (CBN,
2019), Skewing toward the right (4.8134) with a substantial peak value of 32.408. The minimum
value is -0.0001, while the maximum value is 35.240. The standard deviation (4.20) compared to
the mean suggests a slight variation in the AQR of the sampled DMBs.

4.2 Correlation Analysis

This study computed Pearson correlation to establish an association among the variables and test
for any collinearity problem. The outcome of the correlation is displayed in Table 2.

Table 2: Pearson Correlation Matrix

Covariance Analysis: Ordinary
Date: 09/14/23 Time: 01:11
Sample: 2011 2020
Included observations: 100
Correlation
t-Statistic
Probability FINPERF CAR LDR AQR
FINPERF 1.0000
-----
-----
CAR 0.1697 1.0000
1.7049 -----
0.091 -----
LDR 0.3099 0.1181 1.0000
3.2272 1.1779 -----
0.002** 0.242 -----
AQR 0.0505 -0.0054 0.2270 1.0000
0.5010 -0.0535 2.3069 -----
0.618 0.958 0.023* -----
**Correlation is significant at the 0.01 level (2-tailed); *Correlation is significant at the 0.05 level (2-tailed) Dependent Var. FINPERF
Source: Authors’ computation with the aid of Eviews 9 (2023)

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As seen in Table 2, among the independent variables, only LDR correlates positively and
significantly with the dependent variable - FINPERF (p = 0.001; r = .3099). No significant
correlation is seen among the independent variables except for LDR and AQR (p = 0.023; r =
.2270). However, the correlation between LDR and AQR is limited and does not pose a
significant collinearity concern.

4.3 Panel Regression Analysis

According to Gurajati (2004), estimating a panel regression could pose a challenge for
researchers, especially when choosing between using the fixed-effects panel model or the
random-effects panel model. On the one hand, the fixed-effects model controls for omitted
variables that differ between cases but are constant over time. The model allows the use of the
changes in the variables over time to estimate the effects of the independent variables on the
dependent variable (Ajibolade & Sankay, 2013). On the other hand, the random-effects model is
used when there are reasons to believe that some omitted variables may be constant over time but
vary between cases and others fixed between cases but vary over time. Thus, to justify the choice
of model, scholars mostly suggest the Hausman specification test (Ajibolade & Sankay, 2013;
Gujarati, 2004). Accordingly, this study performed the Hausman test to check for a more efficient
model between the fixed-effects and random-effects models. The test assumes a null position that
the fixed-effects and random-effects models give the same efficient outcomes. However, if the
p-value is more than .05, the random-effects model is more efficient, but if the p-value is less
than .05, the fixed-effects model should be adopted (Gujarati, 2004; Oyewumi, Ogunmeru, &
Oboh, 2018). The outcome of the Hausman test is presented in Table 3.

Table 3: Correlated Random Effects - Hausman Test

Test cross-section and period random effects
Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob.

Cross-section random 2.305039 3 0.5116

Period random 0.401066 3 0.9400
Cross-section and period random 1.354897 3 0.7161
Cross-section random effects test comparisons:

Variable Fixed Random Var(Diff.) Prob.

CAR -0.000064 -0.000042 0.000000 0.1738
LDR 0.018157 0.020266 0.000006 0.3824
AQR 0.000625 0.000538 0.000000 0.2555
Source: Authors’ computation with the aid of Eviews 9 (2023)
As seen in Table 3, no statistically significant correlation was found between the unobserved
person-specific random effects and the regressors, as the p-values for the cross-section random
(0.5116), period random (0.9400), and cross-section and period random (0.7161) are all greater
than .05. Therefore, the random-effects model is adopted to test the hypotheses developed for the
study, as it gives a more robust estimation of the model. Based on the choice of model to adopt,
this study employed the Swamy and Arora estimator of component variances to estimate the
regression model and test the hypotheses developed for the study. The results of the EGLS (Two-
way random effects) are presented in Table 4.
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Table 4: Panel Regression Analysis: FINPERFit = β0 + β1CARit + β2LDRit + β3AQRit + εit

Dependent Variable: FINPERF
Method: Panel EGLS (Two-way random effects)
Date: 09/14/23 Time: 01:47
Sample: 2011 2020
Periods included: 10
Cross-sections included: 10
Total panel (balanced) observations: 100
Swamy and Arora estimator of component variances
Variable Coefficient Std. Error t-Statistic Prob.
CAR -4.157460 6.210526 -0.669422 0.5048
LDR 0.020266 0.009935 2.039901 0.0441
AQR 0.000538 0.000342 1.571886 0.1193
C -0.000803 0.007889 -0.101793 0.9191
Effects Specification
S.D. Rho
Cross-section random 0.014637 0.5260
Period random 0.006192 0.0941
Idiosyncratic random 0.012438 0.3798
Weighted Statistics
R-squared 0.091636 Mean dependent var 0.003356
Adjusted R-squared 0.063249 S.D. dependent var 0.012707
S.E. of regression 0.012298 Sum squared resid 0.014520
F-statistic 3.228162 Durbin-Watson stat 1.573979
Prob(F-statistic) 0.025861
Unweighted Statistics
R-squared 0.048800 Mean dependent var 0.013969
Sum squared resid 0.036316 Durbin-Watson stat 0.796489
Source: Authors’ computation with the aid of Eviews 9 (2023)
From Table 4, it is seen that LDR significantly predicts FINPERF, as the p-value (.0441) is less
than .05. The impact of LDR on FINPERF is positive (β = 0.020266), indicating that the higher
the loan-to-deposit ratio, the higher the profitability of DMBs. While the association between
CAR and FINPERF is negative (β = -4.157460) and the association between AQR and FINPERF
is positive (β = 0.000538), the impact of CAR on FINPERF (p = .5048 > .05) and AQR on
FINPERF (p = .1193 > .05) is not significant. However, combining all the independent variables
achieved statistical significance, as indicated by the F-ratio (3.228) and its associated p-values
(0.026). The outcomes of the combined effect of CAR, LDR, and AQR on FINPERF,
representing about 9.2% (R2) and 6.3% (Adj. R2) variation, suggests that the regulations of the
CBN on CAR, LDR, and AQR have a significant effect on the financial performance of DMBs
in Nigeria. The Durbin-Watson test (1.574) suggests that the model did not violate the
independence of residual assumptions (i.e. no collinearity problem) (Field, 2009; Kohler, 1994).

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 Obadimu and Oboh (2024) CJBSS (2024), 15(1), 21-37
Thus, based on the results of the panel regression analysis, the decisions concerning the
hypotheses developed for the study are summarized in Table 5.

Table 5: Summary of the test of hypotheses

Hypothesis Nature of Impact Decision

Relationship
H1: CAR and the financial performance of DMBs are Negative Not Not
positively associated. significant supported
H2: LDR and the financial performance of DMBs are Positive Significant Supported
positively associated.

H3: AQR and the financial performance of DMBs are Positive Not Not
positively associated. significant supported

5. Discussion
Considering the importance of banking regulations and supervision to the success of the banking
industry (Akinjobi, 2022; Iwedi, 2017; Mbatabbey, 2019), this study examined the impact of the
CBN’s regulations on the capital adequacy ratio (CAR), loan-to-deposit ratio (LDR), and asset
quality ratio (AQR) on the financial performance of DMBs in Nigeria. The findings from the
descriptive analysis revealed the extent to which DMBs comply with the CBN guidelines on
CAR, LDR, and AQR. Specifically, the study found that the CAR of the sampled DMBs ranges
from a minimum of -201.59% to a maximum of 30%, averaging about 14.26%, which is higher
than the CBN guidelines of 10% for regional/national banks, and a little bit lower than the 15%
for banks licensed to operate in the international banking business. On examining the data
extracted from the annual reports of the DMBs, while the sampled DMBs complied with the
minimum capital adequacy requirement of the CBN, Unity Bank Plc repeatedly reported a
negative CAR during the period, which the directors linked to uncertainties over the timing of
the recapitalization of the bank.

As to LDR, the study found that the average LDR for the sampled DMBs stood at 63.75%, which
is about the minimum requirement of the CBN, with a minimum value of 8.32% and a maximum
value of 99.16%. The results suggest that, despite being a new requirement (CBN, 2019), the
sampled DMBs are progressing toward achieving full compliance with the LDR guideline of the
CBN. As to AQR, the study found that the average AQR of the sampled DMBs is 4.54%, with a
minimum value of 0.0001% and a maximum value of 35.24%. The results suggest that the
average AQR is less than the CBN’s minimum recommendation of a 5% limit on non-performing
loans, indicating that the asset quality of the sampled DMBs, on average, is within the required
limit (CBN, 2019). Overall, the findings from the descriptive analysis suggest that during the
period, to a large extent, the sampled DMBs complied with the CBN regulatory requirements on
CAR, LDR, and AQR.

In addition, the study found statistical support for hypothesis two, indicating that LDR positively
impacted the financial performance of DMBs. That is to say, not only does the CBN regulation
on LDR keep depositors' funds safe and reduce the risk of illiquidity, but compliance with the

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Obadimu and Oboh (2024) CJBSS (2024), 15(1), 21-37
LDR regulation positively impacts the overall financial performance of DMBs in Nigeria. This
finding agrees with Hadian (2021) on the positive impact of LDR on the financial performance
of DMBs but disagrees with Ajayi and Lawal (2021) and Suroso (2022), who found LDR to have
a negative impact on profitability and Anggari and Dana (2020) and Saleh and Winarso (2021),
who found the effect of LDR on the financial performance of DMBs to be insignificant. While
critics believe higher credit facilities could expose DMBs to illiquidity risks, the findings of this
study suggest that DMBs could improve their financial performance by complying with the CBN
requirement on LDR.

Furthermore, the study found no statistical support for hypotheses one and three contrary to
expectations. While CAR appears to have a negative relationship and AQR appears to have a
positive association, their impact on financial performance is insignificant. The finding on CAR
agrees with Mehta and Bhavani (2017) and Rufai and Olayide (2018), who found no significant
association between CAR and profitability but contradicts Aliyu et al. (2020) and Ikpesu and Oke
(2022), who reported a positive association between capital adequacy and profitability. Though
previous research argues that adequate capital could translate to improved earnings, the finding
of this study suggests that compliance with the CBN regulation on CAR has no significant impact
on the financial performance of DMBs in Nigeria. While the effect is insignificant, the negative
association between CAR and profitability suggests CAR has an adverse influence on
profitability, an assertion that aligns with Singhal et al. (2022) that capitalization has a detrimental
effect on profitability in China and South Africa when considered in light of the agency theory.
As to the regulation of the CBN on AQR, previous research suggests a strong correlation between
AQR and profitability (Ikpesu & Oke, 2022; Obioma & Charles, 2018; Richard & Prakash, 2019).

However, the finding of this study suggests that compliance with the AQR regulation has no
significant impact on the financial performance of DMBs in Nigeria. While this finding aligns
with Trefis (2016) that asset quality alone should not be a key determinant of financial
performance, it did not support the claims of Obioma and Charles (2018) and Udeh (2015) that
many DMBs failed in Nigeria between 2009 and 2010 because of poor asset quality management
and high non-performing loans. Overall, while LDR alone shows a significant impact, the
combined effect of CAR, LDR, and AQR explains about 9.2% (R2) and 6.3% (Adj. R2) variation
in the financial performance of the sampled DMBs.

6. Conclusion and Implications

This study undertakes to shed light on the impact of the regulations and supervision of the CBN
on the financial performance of DMBs. Based on its findings, the study concludes that, to a large
extent, the sampled DMBs complied with the regulatory requirements of the CBN on CAR, LDR,
and AQR within the period. The CAR stood at 14.26% against 10% for regional/national banks
and 15% for banks licensed to operate internationally. The LDR stood at 63.75%, as against the
required 65%, and the AQR was 4.54%, against the minimum recommendation of a 5% limit of
non-performing loans. With the evidence from the panel regression analysis, it is safe to conclude
that the CBN regulation on LDR positively impacts the financial performance of DMBs.
However, the impact of CAR and AQR on the financial performance of the DMBs is
insignificant. The evidence provided in this study has some implications. The study adds to the
small literature on banking regulations in a developing country context. It sheds more light on
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Obadimu and Oboh (2024) CJBSS (2024), 15(1), 21-37
the effects of banking regulations and supervision on the financial performance of DMBs, as it
affirms that the current CBN regulations on CAR and AQR do not necessarily translate to higher
financial performance for DMBs. However, the DMBs are encouraged to comply with the
regulatory requirements of the CBN to avoid regulatory fines and non-compliance sanctions. The
findings of this study will serve as a benchmark for future research on banking regulations in
other developing countries.

7. Limitations and suggestions for future studies

Like in previous research, this study has some limitations. The scope is limited to only DMBs.
Future research could consider including mortgage, merchant, and microfinance banks in the
sample. Also, the study relied solely on secondary data to conclude the impact of CAR, LDR,
and AQR on financial performance. Future research may consider adding primary data to confirm
the association between these variables. Bank managers and regulators could be surveyed via a
questionnaire or interview to obtain first-hand information on the impact of banking regulations
and supervision on the financial performance of DMBs. Finally, this study used CAR, LDR, and
AQR as proxies for banking regulation and supervision and ROA as a proxy for financial
performance. Future research could benefit from alternative variable measurements like deposit
ratio and return on equity.

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Appendix I: Listed Deposit Money Banks in Nigeria

Date of
S/N Banks Ticker Sector
Incorporation
1 Financial
Access Bank Plc ACCESS February 8, 1989
Services
2 Ecobank Transnational Financial
ETI October 3, 1985
Incorporated Services
3 Financial
FBN Holdings Plc FBNH August 13, 2012
Services
4 Financial November 20,
FCMB Group Plc FCMB
Services 2012
5 Financial November 19,
Fidelity Bank Plc FIDELITYBK
Services 1987
6 Guaranty Trust Holding Company Financial
GTCO July 24, 2020
Plc Services
7 Financial
Jaiz Bank Plc JAIZBANK April 1, 2003
Services
8 Financial
Stanbic IBTC Holdings Plc STANBIC March 14, 2012
Services
9 Financial November 25,
Sterling Bank Plc. STERLNBANK
Services 1960
10 Financial
Union Bank Nig. Plc UBN May 30, 1969
Services
11 Financial
United Bank for Africa Plc UBA February 23, 1961
Services
12 Financial
Unity Bank Plc UNITYBNK April 27, 1987
Services
13 Financial
Wema Bank Plc WEMABANK May 2, 1945
Services
14 Financial
Zenith Bank Plc ZENITHBANK May 30, 1990
Services
Extracted from the Nigerian Stock Exchange now Nigerian Exchange Group Website (2022)

37