Impact of Capital Adequacy Risk on the Financial Performance of Microfinance Banks in Nigeria

Abstract

Microfinance banking sub-sector is key to growth and stability, especially in an emerging economy like Nigeria. The sector offers micro-credits to small and medium sized businesses and thus must have sufficient capital to fund their regular operations and guarantee the long-term health of their country's financial system. However, inadequate capital has been reported as a major cause of distress and eventual collapse of banks/financial institutions. Therefore, this study investigated the impact of capital adequacy risk on the financial performance of microfinance banks in Nigeria. Seven microfinance banks operating at the Central Bank of Nigeria's national category were selected and their annual financial reports in the last eleven years were used as panel data for this research. A panel regression model was used to specify the relationship between the dimensions of capital adequacy risk (capital adequacy ratio, operating efficiency & credit risk) and financial performance (return on assets). Descriptive statistical tools such as the mean, standard deviation and Jarque-bera were used to describe the data, while econometric tools such as the LLC unit root, Hausman specification and ordinary least squares technique were used for the inferential analysis. These were done via the E-view 9 statistical software. The results of the analysis revealed that both capital adequacy ratio and cost-to-asset ratio have a direct and significant relationship with return on assets. Similarly, non-performing loan ratio has an inverse and significant relationship with return on asset. The study concludes that capital adequacy ratio, operating efficiency and credit risk are key drivers of profitability among microfinance banks in Nigeria. Therefore, it is recommended that the country's apex bank should enforce compliance with regulations on capital adequacy in the microfinance banking subsector. Furthermore, relevant stakeholders in the bank should ensure prudency in operating cost and monitoring of loan portfolios to reduce defaults.