Dual Effect of Capital Adequacy on Bank Performance: Evidence from Profitability and Efficiency Measures in Nigerian Commercial Banks

Abstract

This study examines the dual effect of capital adequacy on the performance of commercial banks in Nigeria by jointly analysing profitability and operational efficiency outcomes in Nigeria using annual time series data covering the period from 1991 to 2025. Employing an Autoregressive Distributed Lag (ARDL) modelling framework, the study utilises Return on Assets (ROA) and Cost to-Income Ratio (CIR) as proxies for bank performance, while Capital Adequacy Ratio (CAR), Tier 1 Capital Ratio (TIER1), and Capital-to-Total Assets Ratio (CTA) serve as measures of prudential capital regulation. The study adopts ex post facto research design and used secondary time series data from Central Bank of Nigeria Statistical Bulletin, annual reports of commercial banks, and Nigeria Exchange Group publications. The result reveals that capital adequacy exerts heterogeneous effects on bank performance, reflecting an inherent trade-off between regulatory compliance and performance optimisation. Specifically, higher aggregate capital requirements are found to constrain profitability and increase operating costs, thereby weakening efficiency. Conversely, high-quality core capital, particularly Tier 1 capital, significantly enhances long-run profitability and improves operational efficiency by strengthening financial resilience and managerial discipline. The error correction mechanism confirmed existence of a stable long-run relationship between capital adequacy and bank performance, with a relatively rapid speed of adjustment following short-run deviations. Our findings underscored the importance of capital composition rather than capital volume in sustaining bank profitability and efficiency. The study provides important policy implications for banking regulators and managers in designing capital frameworks that promote financial stability without undermining performance. Based on the findings, the study recommends that banking regulators in Nigeria should prioritise capital quality over capital quantity by placing greater emphasis on Tier 1 capital rather than excessively stringent overall capital requirements. Prudential policies should be carefully calibrated to balance financial stability objectives with performance considerations, to avoid unnecessary constraints on lending and operational efficiency. Bank management are encouraged to optimise capital utilisation and strengthen cost efficiency strategies to enhance both profitability and operational performance. The study concludes that a well-structured capital framework that emphasises high-quality capital buffers is essential for achieving sustainable bank performance in Nigeria’s evolving regulatory environment.