Determining a Better Predictor of Bank’s Solvency in Nigeria: Risk- Based Capital or Risk-Independent Capital?
Determining a Better Predictor of Bank’s Solvency in Nigeria: Risk- Based Capital or Risk-Independent Capital?

Summary/Abstract: This study empirically attempts to resolve the trade-off of the potential of risk-based capital and risk-independent capital in predicting bank solvency when measured by bank’s z-score. To achieve the study’s objective, bank-level data of Nigerian deposit money banks listed on the Nigerian Stock Exchange related to seven different measures of capital adequacy and other bank-specific factors are obtained from their annual reports and account between 2012 and 2016. The results reveal the superiority of risk-independent capital in a majority of random-effects models of panel regression analysis. Specifically and in comparison, equity-to-assets ratio is found to be superior to other indicators of capital adequacy using each model’s adjusted R-square. When equity-to assets ratio is paired with each of other capital ratios, the results support the superiority of the model with equity-to-assets and non-performing assets coverage ratios (which are both risk-independent capital measures) having higher adjusted R-square. Some significant results are also found for other bank-specific factors. These findings have policy implications on the regulation of banks in Nigeria most especially regarding coopting non-regulatory measures of capital into regulatory regime. The investors and depositors are also provided with alternative means of analysing bank’s financial condition to ensure their interests are not lost unaware because of the linkage of the z-score to bank’s default risk.

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