Effect of Prudential Regulation on the Financial Performance of Quoted

Deposit Money Banks in Nigeria

Department of Business Administration, Faculty of Management Science

Nile University of Nigeria

been no consensus by previous studies on the effect of prudential regulation on financial performance of

deposit money banks. As such, this study seeks to assess the effect of prudential regulation on the financial

performance of deposit money banks in Nigeria from 2011 to 2020. The prudential regulation is proxied by -

capital adequacy, liquidity, leverage, and asset quality as the independent variables while the financial

performance is proxied by earnings per share (EPS) as dependent variable. The data was sourced from the

annual reports of the thirteen (13) quoted deposit money banks and analysed using descriptive statistics and

Panel Data Regression to determine the relationships between the variables. As a form of diagnostics test,

Jarque-Bera test was engaged for checking for normality, Pearson Correlation was employed to evaluate the

degree of relationship among variables and extent of linearity, Unit root test was used to test for stationarity and

the Hausman test to determine whether to use fixed or random effect panel least square regression of which

liquidity lessens banks’ liquidity risk, asset quality in form of non-performing loans reduces the bank’s capacity

to create further loans, hence less earnings for the bank and leverage negatively influences financial

performance. It is also discovered that control variables - age and size of banks - are positive determining

strengthen capital adequacy by moving it to thresholds that will be impactful enough on the financial

performance, get the banks to improve on asset quality by bringing non-performing loans to the regulatory

limit, be discretional in the use of regulatory forbearance and interventions to bail out the banks to prevent

reckless lending conduct. Lastly, banks are required to pay attention to the capital mix (leverage) to reap its

benefits and manage the associated risk.

reduction by 40%, in the number of commercial

banks in the United States of America within three

(3) years [1]–[3]. This was after the Showa financial

crisis of 1927 in Japan that resulted in poor financial

performance and mass failure of banks across the

Empire of Japan [4], [5]. History would not also

forget the waves of similar systemic failures such as

[12]. Nations around the world have experienced

well over 151 systemic banking crises from 1970 to

2017 [11]–[14]. This has put the banks in the centre

of intense scrutiny, as they were held responsible for

2008/2009 was utmost disregard for prudential

regulation and as such, called for the strengthening

of prudential regulation across the globe. A school

of thought advocated that the global financial

system must adopt a systemic perspective to

prevention and early identification of weaknesses in

the financial system often heralded by negative

financial performance – persistent decline in return

on assets (ROA), earnings per share (EPS), and

other performance measurements - by using a

Nigerian banking system had witnessed the bailout

extended to eight (8) deposit money banks (DMBs),

sacking of the chief executives and boards of those

banks and nationalisation of three (3) banks, into

bridge banks by the Central Bank of Nigeria (CBN)

and Nigerian Deposit Insurance Corporation

(NDIC) in 2009 due to financial distress the banks

suffered as a result of huge non-performing loans

[20], [21]. It became pertinent to tighten its financial

regulation for a safe and sound financial system and

[22]. As of December 31, 2021, Nigeria had thirty-

one (31) deposit money banks of which thirteen (13)

were quoted on the Nigerian Exchange Group

(NGX) [22]. Ten years’ post-implementation of the

new prudential guidelines, some banks have been

meeting the prudential thresholds while some are

still falling short in meeting capital adequacy, non-

performing loan (NPL), and other ratios which are

all integral parts of the prudential regulation for

Nigerian banks [23]. The result of these vagaries is

failed due to severe liquidity problem [28]. In

Nigeria, the annual reports of Unity bank plc

showed that the bank made losses in 4 years (2013,

2016, 2017, 2018) out of 10 years post introduction

Vietnam, Iran, Saudi, Nepal, Barbados, Jamaica,

Trinidad and Tobago, Jordan, India, Indonesia,

Pakistan, Oman, Ethiopia, Bangladesh, Rwanda,

Kenya, Morocco, Kenya and South Africa and

locally (Nigeria) in relation to prudential regulation

and its effect on banks’ financial performance.

Some of the studies which examined the individual

components of prudential regulation and financial

performance are [1], [14]–[17], [29], [30], [30]–

[42], [42] and found significant effect of the

performance on the ground that availability of

liquidity is a risk-taking incentive which if well

managed, results to better bank performance and if

poorly managed, poor bank performance. studies by

[18] who found out that banks that hold higher

fraction of liquid assets in cash and government

securities tend to have a lower net interest margin

than banks with less liquid assets in his works to

examine the impact of the liquidity management on

profitability in the Jordanian commercial banks.

the study on banks in Pakistan. Still on banks

operating in Pakistan, [41] extended the study

testing liquidity impact on EPS, ROA, ROI, ROE

and net profit margin averred that ROA and ROE

have positive relationship with liquidity but EPS

and ROI have adverse relationship with liquidity.

Lastly, [18] investigated the relationship between

bank’s loan creation as a measure of liquidity and

financial performance for two banks in Jordan and

the result of the study indicated that there was a

abuses in some cases. All of these are around the

depositors’ funds [21]. The safety of depositors’

funds should not be compromised. As such, there

has to be a regulatory body that will set rules and

The study was a panel (longitudinal and time series)

survey of quoted banks on the Nigerian Exchange

Group (NGX Group) and the descriptive research

methodology was employed. The variables

examined consisted of Earnings Per Share (EPS) as

proxies for bank’s financial performance which is

the dependent variable and Capital adequacy,

Liquidity, Risk Asset Quality and Leverage which

represent the independent variables. Emphasis was

on prudential guidelines that have taken place in

For this study, the panel cross-sectional and time-

series secondary data collected were analyzed using

the Static Panel Regression estimation procedure

suggested by [29], [36], [39], [52]. The study’s

model specification is adopted from the study [39],

who also investigated the effect of prudential

regulations (guidelines) on financial performance.

Therefore, the model specification for the test of the

posited hypotheses is stated thus:

For this study, the model is specified as:

the CBN’s set minimum limit of 30%; a clear

indication that the Nigerian DMBs are liquid on the

average. The average non-performing loan which

reflects the asset quality of the DMBs in the stated

within the regulatory maximum allowable limit of

25%. This reflects a good capital mix among

Nigerian DMBs. More importantly, regarding the

test for normality, as observed in table 4.1, the test

for all the variables returned a p-value less than 0.05

(5%) level of significance, thus, implying that the

variables are normally distributed. As such, the

variable natural logarithm transformation is used to

correct for the non-normality seen in the series

before modelling in sub-section 3.4.

stationarity if a shift in time causes a change in

shape of the distribution. Unit root is a cause for

non-stationarity. The test result and interpretation

are contained in Unit-Root Table 2.

Table 2. Unit-Root

Source: Stata 15 Output

Effect or Random Effect model for the study

hypotheses testing and interpretation.

multiplier test (LM) and Hausman test are reported

thus suggests the presence of random effect and

such the pooled OLS model is not the best for the

test hypothesis. However, the Hausman test will be

required to select the best model between fixed and

random effect model since the pooled OLS is

removed by LM test.

As observed from the Hausman test p-value (0.000)

which is less than the 0.05 (5%) level of

capital large enough to the point of generating

significant profit or sub-optimal use of capital

leading to sub-optimal financial performance.

are of contrary view and opinion. They claimed that

the capital adequacy does not influence improved

financial performance. Rather, banks do raise capital

for other objectives such as, providing adequate

cushions for risks, and not for profit motive [29].

earnings per share of Nigerian quoted deposit

money banks: The variable liquidity (LIQ) has a

panel regression coefficient of 0.1804 for EPS,

which implies that the liquidity (LIQ) has a positive

observed to be greater than 5% level of significance

adopted for the study under EPS, therefore, the

relationship is not statistically significant for EPS.

Hence, the null hypothesis is not rejected. Thus, we

conclude that liquidity has a positive but not

significant effect on the banks’ earnings per share.

This result is consistent with the studies conducted

by [40], [32] and [42], [44], [46] and [40] who

agreed with the finding to the extent that there was a

positive but a non-significant relationship between

via lending to SMEs, Retail, Mortgage and

Consumer products. High liquidity means more

available funds to meet depositors’ expectations,

more working capital to finance transactions that

will generate more profit. In total disagreement to

the results of the findings, [52] and [16] shared a

contrary opinion and submitted that there was a

negative relationship between liquidity management

and financial performance.

Control Variables - Age and Bank Size: At co-

efficient of 25.6899 and p-value of 0.000, it shows

that bank age has a positive and significant

relationship with bank’s financial performance

result is consistent with previous study in Ghana on

bank profitability determinants and other similar

studies in other jurisdictions [34].

word, so the banks have to ensure that financing risk

is not increased beyond the acceptable thresholds,

which is capable of leading to lower returns to

shareholders.

levels of systemic risk.

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