Effect of capital adequacy on the profitability of the

Journal of Money, Investment and Banking
ISSN 1450-288X Issue 24 (2012)
© EuroJournals Publishing, Inc. 2012
http://www.journalofmoneyinvestmentandbanking.com

Effect of Capital Adequacy on the Profitability of the
Nigerian Banking Sector

A. A. Onaolapo
Department of Management and Accounting
Ladoke Akintola University of Technology, Ogbomosho Nigeria
E-mail: adeonap4real@gmail.com
Tel: 234-80-3389-2807

Adebayo, E. Olufemi
Department of Accounting, Banking and Finance Caleb University
Imota, Lagos Nigeria
E-mail: Olufemiadebayo@yahoo.com

Abstract

Nigerian banks like their counterparts in other nations of the world are mandated
statutorily to maintain a given level of capital to support operations. This paper examines
the effects of such capital adequacy conditionality on the performance of selected banks
within the Nigerian banking sector. The study hypothesized no significance between
Capital Adequacy Ratio (CAR) (Statutorily mandated) and five bank performance
variables. Data employed are mainly secondary and were obtained from the publications of
regulatory agencies like the Central Bank of Nigeria in a ten year period 1999-2008.
Ordinary Least Square (OLS) estimation obtained from an SPSS 17.0 package is adapted to
analyze relationship between the variables while The Augmented Dickey Fuller (ADF) is
used to test the stationary of the time series data employed. A pair wise Granger Causality
is further used to determine co-integration between the study variables. Findings indicate
that all the performance indicators tested such as Returns on Assets (ROA), Returns on
Capital Employed (ROCE) and Efficiency Ratios (ER) among others do not reflect much
on Capital Adequacy Ratio (CAR) of the Nigerian banking sector. The non-significance
relationship between reflective adjustment in banks’ capital base, profitability and
performance informed the paper recommendations for pragmatic changes in bank
regulatory focus, improved corporate governance, personnel training and stable polity as
antidotes for ensuring sound financial health for the Nigerian banking sector.

Keywords: Capital Adequacy of Banks, Bank Capital, Bank Profit and Performance
Indicators of Banking Sectors.

1. Introduction
The spate of bank failures and the attendant losses to the banking public have created an increasing
need for enhanced regulation of banks. This has pitched the regulatory authorities against the banks.
Efforts to shore up the soundness of the financial system by the regulatory authorities are countered by
charges of economic injury and competitive disadvantage by the banks.

Journal of Money, Investment and Banking - Issue 24 (2012) 62

Every business exerts considerable influence on its environment, customers, the government
and the general public and this is derived from its financial resources and profitability which is a
function of availability of funds to prosecute identified investment.
Bank capital has always been a central and vexing issue in the context of financial health and
safety of a bank. It can in fact be said that the ultimate strength of a bank lies in its capital funds given
its significance as a tool for meeting liabilities in a financial crisis and as a cushion for insulating a
bank from the vagaries of the market adversity. For a bank to enjoy depositors’ confidence, it must
have a strong capital base as evidence of its strength and a tool for operating profitably so that
shareholders’ funds can increase through accretion to statutory and general reserves. Every business
exerts considerable influence on its environment, customers, the government and the general public
and this is derived from its financial resources and profitability which is a function of availability of
funds to prosecute identified investment.
In past years, the world has witnessed ‘the crack’ and in some cases, total collapse of major
financial institutions, which before then, had made and declared significant and sometimes enviable
returns. Following these collapse, there was a need to review the contradiction that played out in some
of these cases, between declaration of significant returns and sudden death. This informs the evaluation
of banks’ performance from a risk adjusted bases. Banks are among the most leveraged businesses with
substantial proportion of their assets in loan and advances exposing them to considerable risk. There is
also an established fact of risk – return relationship whereby the higher the risk taken the higher the
return expected. In essence, banks by the nature of their operations may make substantial profit from
loans and advances but without commensurate level of capital to cushion unanticipated losses may fail.

1.1. Statement of the Problem
Adjustment in bank capital sizes has constituted a significant policy focus of regulatory reforms in the
last sixty years of the Nigerian banking system-operations. The watershed for regulatory adjustment
and re-engineering of Nigerian bank capital and adequacy compliance commenced with the Parton
Commission of Enquiry 1951 which culminated in the enactment of the first Nigerian banking law
(The 1952 Banking Ordinance). This and subsequent regulatory framework, both local and
international including the Central Bank of Nigeria Act 1959; the Banking Decree 1969, the Central
Bank of Nigeria Decree (24) 1991; Banks and other Financial institution Decree (25) 1991; Basle1 and
2 as well as Bank Consolidation policy of 2004 emphasized the need for capital adequacy and upward
adjustment in Nigerian banks statutory capital. For instance; Nigerian bank regulatory authorities
seemed to have incorporated upward adjustments on statutory capital as a major policy focus since
1988 without corresponding linearity between the increases and bank distress management. Table 1.0
below presents relationship between bank capital adjustments and distress management.

Table 1: Recapitalization of the Nigerian Banking System and incidence of Distress 1988-2008

Numbers of Operating Number of Distressed Distressed Banks as % Minimum Regulatory
Years
deposit Banks Deposit Banks Total Deposit Banks Capital
1988 64 7 10.9 N10m.
1990 107 9 8.4 N10m.
1992 120 16 12.6 N50m.
1995 115 58 52.2 N50m.
1997 115 60 61. N500m.
1998 89 12 24.7 N500m.
1999 90 10 11.1 N500m.
2001 90 - - N1b.
2003 87 3 3.7 N2b.
2004 89 4 - N25b.
2005 25 13 14.6 N25b.
2008 24 7 - N25b.
Source: NDIC Annual Report – Various Publications 1988-2008.

63 Journal of Money, Investment and Banking - Issue 24 (2012)

Emphasis on continuous increases in regulatory capital as antidotes for ensuring stability and
solvency within the Nigerian banking system seemed to have overlooked balanced interaction between
personnel management, policy suitability and environmental stability; hence continuous incidence of
bank distress (Soyibo and Odusola (2003) Ayida (2004), Adedipe 2005, and Onaolapo 2007. Capital
adequacy management among its other significances is designed to provide cushion for absorbing
operational losses; afford some measures of shareholders confidence and reveals the bank’s ability to
finance its capital project as well as ensure some level of protection for depositors’ funds; Greuning
and Bratanovic (2003). Based on these justifications, Nigerian bank regulatory authorities most
especially the Central Bank of Nigeria (CBN) have within the last 22years instituted various reforms
that culminated in over 1000% increases in deposit bank statutory capital. In spite of the noticeable
changes in regulatory capital, incidence of distress has remain a permanent phenomenon of the sector
leading to the recent establishment of Asset Management Company of Nigeria (AMCON)and the take
over of the boards of management of seven problem banks within the last three years 2009 – 2011.
Given the spate of capital adequacy measures put in place to stabilize the financial health of the
Nigerian banking sector vis-à-vis the incidence of sectoral distress, this paper examine the following
research questions/objectives:-
(i) Does Capital Adequacy management influence Nigerian deposit bank Returns on Asset
(ROA)?.
(ii) To what extent does compliance with Capital Adequacy conditionality influence
operational efficiency among selected Nigerian deposit banks?
(iii) What impacts does capital adequacy compliance has on bank profitability and Returns on
Capital Employed (ROCE)?.
Establishing the functional role of capital vis-à-vis profitability, level of performance and
public confidence in banks emphasize the need for a capital adequacy as a means for sustaining sound
financial system. Generally both the regulatory authority and bankers to some extent agree on the
significance of some level of capitalization for normal operation. The bone of contention lies on how to
determine what proportion is adequate and the causality between the level of capital and bank
performance.
This study therefore examines issues relating to the specific roles of capital adequacy and its
impact on bank profitability.

2. Literature Review and Theoretical Framework
2.1. Capital and Capital Adequacy
The significance of start-up and operating capital to any business cannot be over emphasized and
according to the submission of many financial theorists, the term capital is capable of being a source of
confusion because of the variety of meanings which can be assigned to it, Ebhodage (1991), Greuning
and Poratanovic (2003), and Satchindananda (2006). To the economist, capital refers to “real” capital
which is the stock of goods accumulated through production while in business and finances, it is seen
as “financial capital” which in itself could sometimes mean both tangible and intangible capital; Klise
(1972). On the other hand, Arogundade (1999) defines capital as the owner’s stake in business and
therefore a commitment to its success. Opinion however, differs among experts in banking and finance
as to what constitutes capital adequacy; for instance Nwankwo (1991) submits that the question of how
much capital a bank needs to ensure the stakeholders confidence and sustain healthy operations is
determined by the supervisory and regulatory authorities.
Umoh (1991) noted that adequate capitalization is an important variable in business and it is
more so in the business of using other people’s monies such as banking. It is further stated that insured
banks must have enough capital to provide a cushion for absorbing possible losses or provide, funds
for its internal needs and for expansion, as well as ensure security for depositors and the depositor
insurance system. Regulators and bankers have also not reached agreement as to what level of


capitalization is adequate; for instance while regulators concern themselves primarily with the safety of
banks, the viability of invested funds, and stability of financial markets, sbankers generally prefer to
operate with less capital, as the smaller its equity base the greater the financial leverage. Rose (1999)
buttressed Koch’s stand by stating that even a bank with a low return on assets can achieve a relatively
high return on equity through heavy use of debt (leverage) and minimal use of owner’s capital.
Kidwell et al (2000), on the issue of capital adequacy observed banks and regulators differ
because they have different objectives. The primary goal of bank management is long term profit
maximization achievable through high leverage while bank regulators are more interested in the risk of
bank failures in general. Hence, bank regulators desire higher capital standards that promote bank
safety.

2.2. Function of Capital
The primary function of capital is to finance the purchase of building, machinery and equipment while
its secondary function is to protect long and short tem creditors who make funds available to the
business. However, in banking, the function of capital is primarily to serve as a cushion on loaned
funds to absorb losses that may occur. It also serves the function for the acquisition of physical assets;
Rosse (1964) , Crosses and Hamsel (1980) and the Economist (1999) .
Bank capital affords the “engine and bumper” that keeps the bank, going as well as absorbing
nasty shocks and the more capital a bank has, the better it is able to sustain losses without running into
insolvency. For instance a bank statutory capital primarily serves as a indicator of bank growth, ensure
funds for the organization’s growth and afford the development of new service, programs and
facilities; and a ‘tether ‘ for regulatory agencies to limit how much risk exposure banks can accept. It
thus protect the government deposit insurance system from serious losses. In spite of the controversy
over the roles of capital between bankers and regulators coupled with the fact that its function will
largely determine the quantity or amount of capital considered adequate for banking business, there
seems to be similarity between the parties’ stands on the various purposes of capital. This has led to the
classification of the roles of capital in banking into primary and secondary; the former function
affording banks operational latitudes while the latter bring about efficiency. Other review of banking
literatures has shown that regulators place high premium on the primary functions while bankers
emphasized secondary roles.
Nwankwo (1991) stated that the indispensability of capital in banking lies on its functional
significance at the various stages in a bank’s life cycle; for instance at the commencement it satisfies
the statutory minimum requirement as well as compensate for lack of profit that is generally the
characteristic of business at the early years of operation. As a bank matures, additional capital would
be needed to cushion expansion and absorb operational losses and where the third stage is
characterized with either illiquidity or bankruptcy many banks survive these hazards through the
application of capital as a tool for protecting depositors and other creditors.

2.3. Components of Bank Capital
Accounting theory defines capital, simultaneously as a net worth which equals the cumulative value of
liability and represents ownership interests in a firm. In banking, the regulators concept of bank capital
differs substantially from accounting capital. Specifically, regulators exercise some level of depth
when measuring capital adequacy and they refer to “capital” as those funds contributed by the banks
owners consisting principally of stock, surplus (reserves) for contingencies and retained earnings. A
balance sheet classification of a bank capital will generally include ordinary share capital or equity,
reserves (statutory reserves, general reserves and retained earnings), and preference shares. Loan
Capital may be referred to as long term capital while reserves may also include share premium and
revaluation reserves; Rose (1999) and Arogundade (1999). Since the universal adoption of the 1988
Basle Accord by many banks; operational capital has been re-defined to consist of core capital


(primary or tier 1 capital) and supplemental capital (secondary or tier 2 capital). Thus Components of
the two tiers of a bank capital will include Equity capital i.e Common stock + perpetual preferred
stock + Surplus fund + Bonus issue reserve + Minority equity interest in subsidiary companies; while
Core capital refers to Equity Capital – goodwill (other intangible assets). Another class of capital
commonly referred to as Supplemental capital relates to Provision for loan loss + preferential shares
+ Convertible securities (hybrid capital instruments) + Revaluation reserves.

2.4. Capital Adequacy Measurement and Profitability
Crosse and Hamsel (1980) stated that the adequacy of capital is a dynamic concept and it is influenced
by the prevailing and expected economic conditions of the entire economy. Ebhodaghe (1991) defines
capital adequacy as a situation where the adjusted capital is sufficient to absorb all losses and cover
fixed assets of the bank leaving a comfortable surplus for the current operation and future
expansion.Functionally, adequate capital is regarded as the amount of capital that can effectively
discharge the primary function of preventing bank failures by absorbing losses. On the other hand
measurement of capital for adequacy purposes is determined by several factors (both internal and
external) influencing the level of risk occasioned by operation. Furthermore the level of capital
perceived to be adequate at one time may need to be adjusted over time as the risk characteristics the
competitive environment, markets and economic conditions in which the bank operates change. The
Basel Accord (1988) as international standard of capital adequacy recognizes the ratio of capital funds
to deposit and has informed the adoption of a rule of thumb that a bank should have capital funds equal
to at least 10% of its deposit liabilities. The minimum risk-based standard for capital adequacy was set
by Basel Accord, 1 at 8% of risk-weighted assets of which the core capital element should be at least
4%. Oftentimes a bank statutory capital is considered as adequate if it is enough to cover the bank’s
operational expenses, satisfy customers’ withdrawal needs and protect depositors against total or
partial loss of deposits in the event of liquidation or losses sustained by the bank; Onuh (2002) Crosse
and Hamsel (1980)
The nexus between capitalization and profitability is particularly pronounced given the
significance of business profit as a tool for risk mitigation, business survival and a sign of successful
product development.

Figure 2.1: Inter-relationship Between Capitalization and Bank performance Metrics

Profitability

Risk Minimization Capitalization Business Survival

Product Devt.
Source: Authors design

At the centre of every capitalization attempt made by a bank is the need to ensure a balance
between sustainable product developments, profitability and risk mitigation. For instance, a sound
banking system is built on profitability and adequacy of capital.. Profitability is a revealing indicator of
the efficiency of a bank competitiveness in the markets and the quality of its managements. Both the
level of capitalization and profitability are used as indicators of bank risk management efficiency and
the extent of ‘cushion’ available in case the ‘unexpected’ arises. Profitability in form of retained
earnings is typically one of the likely sources of capital generation.


Crosse and Hamsel (1980) stated that capital has to do with the bank’s ability to generate
income. and a means for expanding its operations, deliver quality service and hence remain
competitive. This, no doubt, is critical to income generation as growth of balance sheet is not possible
without adequate capital; Greeuning and Bratanovic (1993) Rosse and Hamsel (1980).
Capital adequacy is also an important indicators of the strength of a bank. The best
management cannot turn around an ailing financial institution if it does not have an adequate capital. In
essence a direct implication of capital adequacy requirement is that it limits the risk profile of
investment of a bank and therefore affects its capacity to achieve a target level of profitability. The
essence capital adequacy lies on the needs to manage or re-structure the balance sheet given the linear
relationship between bank profitability; core capital ratio and the risk-based capital ratio. Increase in
capital ceteris paribus is expected to enhance earnings by reducing the expected cost of financial
distress including bankruptcy; Oluyemi (1996) Nanon (1999) and Mathura (2009). Alexandre and
Fabiano (2004) also emphasised on the importance of inflation in the analysis of profitability and
capital adequacy. It was noted that the validity of any analysis of profitability and capital adequacy lies
on the significance of profitability as an appropriate measure of income and the essence of capital size
as an indicators of monetary concept of capital maintenance in terms of general purchasing power be
based on restated historical cost.

3. Research Methodology
The study employed secondary data that were obtained from publications of the Central Bank of
Nigeria, (CBN), the National Bureau of Statistics, (NBS), The Nigerian Deposit Insurance Corporation
and other relevant publications. Information used cover a period of ten years. The OLS estimation is
obtained from SPSS 17.0 adopted for the purpose of the analysis. The stationary of the time series is
tested using the Augmented Dickey Fuller (ADF) Unit Root Test (as obtained from EViews7) for the
variables adopted in the study. In addition, the Pair wise Granger Causality Test (GCT), is further used
for co-integration test between the variables. The hypothesis for study states that Capital Adequacy
does not affect the profitability of any of the sampled Nigerian deposit money bank.

Models 1 –7 presented below are used to relate the study variables:
CAR = β 0 + β 1 RA + µ 1 (1)
CAR = β 0 + β 1 EFR + µ 2 (2)
CAR = βo + β1PBT + µ3 (3)
CAR = β0 + β1 ROCE + µ4 (4)
CAR = ΒO + Β1INFR + µ5 (5)
CAR = β0 + β1RA + β2ROCE + µ6 (6)
CAR = β 0 + β 1 RA + β 2 EFR + β3PBT + β4ROCE + β5INFR + µ7 (7)
Where βo --- βn are coefficients of the expletory variables N; the error terms and
CAR = Capital Adequacy Ratio
RA = Return on Assets
EFR = Efficiency Ratio
PBT = Percentage Growth of Profit before Tax
ROCE = Return on Capital Employed
INFR = Inflation Rate


3.1. Analysis of Data and Presentation of Result
Table 1: Capital Adequacy and banks Returns on Assets. (ROA)

Dependent variable: CAR
Unstandardized Coefficient
Variable Standardized Coefficient t – Statistic
B Std. Error
Constant 19.725 8.847 2.230
RA -0.035 -0.274 2.801 -0.098
R- squared 0.001
Adjusted R- squared -0.124
D-W statistic 2.403
F – ratio 0.010
Source: SPSS Output Generated based on data analysed

From table 1 above, the marginal contribution of the independent variable – Return on Assets
of banks to the dependent variable Capital Adequacy Ratio is negative and the degree of fitness is just
too insignificant from the above result. However, the standard error of the independent variable is low
thereby producing a very low statistical noise in the estimates. The DW is above 2 and this signifies the
presence of a negative serial correlation between the dependent and independent variables.
The result for Model 2 is not far away from that of Model 1. The R2 is insignificant and the
coefficient of EFR is ridiculously low. The standard error is less than 0.2. It shows therefore that
Efficiency Ratio unilaterally may not create any alarm on the Capital Adequacy Ratio of Banks.

Table 2: General Adequacy and Bank Operational Efficiency

B Std. Error
Constant 17.761 10.767 1.650
EFR 0.039 0.019 0.173 0.109
R- squared (R2) 0.001
Adjusted R squared -0.123
D-W statistic 2.437
F – ratio 0.12

Table 3: Capital Adequacy Ratio and Bank Profitability

B Std. Error
Constant 17.760 2.771 6.409
PBT 0.336 0.028 0.028 1.010
R- squared(R2) 0.113
Adjusted R squared 0.002
D-W statistic 2.575
F – ratio 1.020

From table 3 above, there is a positive relationship between Capital Adequacy Ratio and
Percentage growth of Profit before Tax (PBT). Just like the two results above, the degree of fitness is
very poor. By virtue of this result, variations in PBT will result in an infinitesimal change on CAR. The
DW result for the relationship shows a negative serial correlation. The standard error is also low and
this depicts a poor statistical reliability of the coefficient estimates.


The result for Model 4 (Table 4) below is worst than the three above. The R2 is zero and a poor
negative relationship. The Standard Error is also very low and the DW is a situation of negative serial
correlation.

Table 4: Capital Adequacy Ratio and Bank Returns on Capital Employed

B Std. Error
Constant 19.095 6.470 2.951
ROCE -0.012 -0.007 0.212 -0.033
R- squared 0.000
D-W statistic 2.426
F – ratio 0.001

Table 5: inflationary effect on Bank Capital Adequacy Ratio

B Std. Error
Constant 25.013 7.041 3.552
INFR -0.313 -0.520 0.558 -0.931
R- squared 0.098
D-W statistic 2.435
F – ratio 0.867

Models 5 (Table 5) and 6 (Table 6) results are not far away from those of Models 1 to 4. The
independent variables show a very minute fraction of variance in the dependent variable. Standard
Errors are just too low and the DW results give a negative serial correlation.

Table 6: Bank Capital Adequacy and Returns on Investment.

B Std. Error
Constant 19.725 9.456 2.086
RA -0.051 -0.407 4.177 -0.098
ROCE 0.024 0.015 0.316 0.046
R- squared 0.001
D-W statistic 2.396
F – ratio 0.005

The result of Model 7 below (Table 7) gives R2 of 27.1%, indicating that 27.1% variation in the
dependent variable will be explained by the independent variables. However, the Adjusted R-squared
is -0.64 and this is because all variables in the independent variables had earlier shown poor fittings in
the previous models. By implication, 64% variation in the dependent variable will be negatively
explained by all the independent variables. The D-W statistic is 2.48 (which lie between 2 and 4) and
this indicates a degree of negative autocorrelation. The marginal contributions of the various
independent variables to the dependent variable (assuming all other variables are constant) are strong


except for INFR which is 0.164. RA has -0.997, a negative but strong relationship. EFR is also good
with -0.52. However, PBT and ROCE have 0.949 and 0.968 respectively. These show strong positive
relationships with the dependent variable. The value of the F-ratio (0.297) is low and this is not close to
1. A resultant effect of this is to accept the null hypothesis. The values of t-statistic calculated are lower
than the tabulated value t-statistic at 95% significant level which also signifies the acceptance of the
null hypothesis.

Table 7: Bank Capital Adequacy, Profitability and Inflation

B Std. Error
Constant 35.507 26.392 1.345
RA -0.997 -7.903 9.464 -0.835
EFR -0.520 -0.256 0.334 -0.766
PBT 0.949 0.079 0.089 0.887
ROCE 0.968 0.580 0.666 0.872
INFR 0.164 0.272 1.405 0.194
R- squared 0.271
Adjusted R-squared -0.640
D-W statistic 2.481
F – ratio 0.297

Table 8 below gives the ADF Statistic values (tα) and associated one-sided probabilities (ρ–
values). It also reports the critical values of the 5% level. Following the rule, we do not reject the null
hypothesis if tα value is greater than the critical values. Also, a ρ–value that is lower than the 5% (0.05)
significant level is taken as evidence to reject the null hypothesis of a zero coefficient. The ADF
Statistic values for all the regressors are greater than their corresponding 5% critical values at the level
and the first difference, hence the need to accept the null hypothesis that is Capital Adequacy will not
affect the profitability of any bank.
Under the assumption that the errors are normally distributed or that the estimated coefficients
are asymptotically normally distributed, the ρ–values of the t-statistic need to be examined in drawing
our conclusion. The ρ–values for all the independent variables and first difference are greater than 0.05
thus, signifying evidence to accept the null hypothesis.

Table 8: Augmented Dickey Fuller (ADF) Test Statistics

LEVEL FIRST DIFFERENCE SECOND DIFFERENCE
5% 5% 5%
VARIABLES t- t- t-
Prob* Critical Prob* Critical Prob* Critical
Statistic Statistic Statistic
Level Level Level
CAR -4.89 0.026 -4.25 -4.50 0.048 -4.45 -15.46 0.0002 -4.77
RA -2.95 0.211 -4.25 -2.56 0.305 -4.25 -7.79 0.0067 -4.77
EFR -3.41 0.116 -4.11 -3.66 0.111 -4.45 -4.54 0.0621 -4.77
PBT -2.79 0.238 -4.11 -3.92 0.083 -4.45 -2.36 0.3667 -4.77
ROCE -3.08 0.178 -4.25 -2.40 0.355 -4.25 -6.73 0.0122 -4.77
INFR -2.39 0.363 -4.11 -2.71 0.269 -4.45 -4.67 0.0414 -4.45
Prob* - Mackinnon (1996) one–sided p-values

The ADF Unit Root test result in table 9 below is used to test the stationary of the time series.
All the variables are non-stationary at level for the intercept. At the first difference, all except RA are
non-stationary at the intercept. These imply that the variance in CAR increases with time and
approaches infinity but with trend at level, RA and INFR are stationary. However, INFR became non-


stationary at the second difference with trend, but RA was stationary at first difference and second
difference with trend. From the result of the Unit Root test, it shows that all the independent variables
are non-stationary at one point or the other (either at the Level, First Difference or Second Difference).
This shows that the variance of all these variables increases with time and approaches infinity.

COEFFICIENT AT
COEFFICIENT AT COEFFICIENT AT
SECOND
LEVEL FIRST DIFFERENCE ORDER OF
VARIABLES DIFFERENCE
INTEGRATION
INTERCE INTERCE INTERCE
TREND TREND TREND
PT PT PT
CAR 12.42 1.28 -7.19 1.271 15.315 -2.001 I(1)
RA 6.28 -0.21 -0.082 0.049 -5.147 0.811 I(1)
EFR 99.16 -2..69 -38.178 5.133 35.465 -4.769 I(1)
PBT -45.34 18.89 -281.33 57.45 7.61 9.101 I(1)
ROCE 79.28 -6.64 -4.135 0.391 -42.823 6.688 I(1)
INFR 12.96 -0.46 9.96 -1.839 -14.72 2.276 I(1)

Table 10: GRANGER TEST 2LAG

Pairwise Granger Causality Tests
Date: 07/22/11
Sample: 1999-2008
Lagos: 2
Null Hypothesis: Obs F-Statisc Prob.
RA does not Granger Cause CAR 8 1.07708 0.4441
`CAR does not Granger Cause RA 1.69369 0.3219
EFR does not Granger Cause CAR 8 0.03821 0.9630
CAR does not Granger Cause EFR 4.58528 0.1224
PBT does not Granger Cause CAR 8 0.79057 0.5299
CAR does not Granger Cause PBT 8 0.23745 0.8022
ROCE does not Granger Cause CAR 8 2.52058 0.2279
CAR does not Granger Cause ROCE 8 11.8678 0.0376
INFR does not Granger Cause CAR 8 0.65328 0.5814
CAR does not Granger Cause INFR

The results of the Granger causality test show the statistics for the joint significance of each of
the lagged endogenous variables in the models above. The probability (ρ–values) of the F-statistic for
the joint significance between CAR and AR; CAR and EFR; CAR and PBT; CAR and INFR; and,
CAR and ROCE are greater than the significance level of 0.05, therefore we accept the null hypothesis.
The results of most of the F-statistic are very high and by virtue of this, most of the endogenous
variables can be treated as exogenous variables.

5. Conclusion and Recommendation
The results of the various tests carried out under this study accept the Null
Hypothesis which states that - Capital Adequacy will not affect the profitability of any bank. It
implies that the various efforts by the monetary authority to review often times the capital base of the
banking sector is not borne out of the aim to improve the profitability of the banks but mainly to
maintain stability in the banking industry. This will be noticed from the various actions of the Central
Bank of Nigeria (CBN) in the recent time which come heavily on ailing banks in terms of restructuring
managements, outright revocation of licences and nationalization of some of the banks. Also to be
observed from these actions was the quest to protect depositors and not investors or owners of these
banks. It should be noted from some of the reviewed literatures that strong capital base strengthened


the ability of banks to sail through the storm of the challenges in the course of their trading activities
and also to withstand the competitive environment. The statutory capital requirement may not have
anything to do with bank performance most especially if the ‘adequate capital’ is not properly
managed. This does not mean however that strong capital base or weak capital base will not have
anything to do with the performance of banks, but rather the influence is likely to be subjected to so
many factors among which are operational management, adequate corporate governance, economic and
political environment, global financial situation, quality of staff and the likes.
The incidence of non-significance between capital Adequacy Ration (CAR), and selected bank
profitability and performance informed recommendations that Nigeria financial regulators need to
focus attention on intrinsic elements of bank operational activates in particular regulatory framework
that review personal and asset management qualities, corporate governance and strategic focus of
Nigeria commercial banks will go a long way in ensuring stable financial environment for deposit
money banks and kindred financial institutions within the system.

References
[1] Adebayo, E. O (2010): “Capital Adequacy: Instrument for Sustainable Growth and
Development in the Nigerian Banking Sector”; Journal of Management Skills and Techniques,
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