1.1 Background to the Study
Capital Adequacy Ratio (CAR) is one of the fundamental measures of the strength and wellness of banks the world over. The term is an important measure of ―safety and soundness‖ for banks and depository institutions because it serves as a buffer or cushion for absorbing losses (Abba, Peter, & Inyang, 2013). Capital Adequacy is the first letter ‗C‘, in the popular acronym ‗CAMELS‘ in banking parlance. The importance of the concept has drawn the attention of financial experts and policy makers both locally and internationally, especially Central Banks, Federal Reserves, Deposit money banks, Insurance Companies and the World Bank and has led to the popular Basel Accords. The Basel Capital Accord is an international standard for the calculation of capital adequacy ratios. The Accord recommends minimum capital adequacy ratios that banks should meet. Applying minimum capital adequacy ratios serves to promote the stability and efficiency of the financial system by reducing the likelihood of banks becoming insolvent. When a bank becomes insolvent, this may lead to loss of confidence in the financial system, causing financial problems for other banks and perhaps threatening the smooth functioning of financial markets.
Lindgren, Garcia and Saal (1996) observed that since 1980, over 130 countries, comprising almost three fourths of the International Monetary Fund‘s member countries, have experienced significant banking sector problems, with 41 instances of crisis in 36 countries and 108 instances of significant problems. This situation posed serious concern for the policy makers and regulators. In the aftermath of the financial crisis, there have been efforts by regulatory authorities to make banks stronger. To accomplish this, governments across the developed and developing worlds are1compelling banks to raise fresh capital and strengthen their balancesheets, and if banks cannot raise more capital, they are told to shrink the amount of risk assets (loans) on their books. In the case of Nigeria, the Central Bank of Nigeria, being the apex regulator of the banking industry increased the minimum capital base for commercial banks to twenty-five billion naira in 2005. This policy popularly referred to as the recapitalization or consolidation policy resulted in the reduction of Nigeria motley group of mainly anaemic eighty-nine banks to twenty-five bigger, stronger and more resilient financial institutions (Williams, 2011
The global response of the fragility and incessant crisis that characterised the banking world is the Basel Accords. The Basel Committee on Banking Supervision handed down the first Basel Accord in 1988 which is the popularly referred to as Basel I. This marked a significant milestone in the governance of the global financial system as it focused on defining regulatory capital, measuring risk-weighted assets, and setting minimum acceptable levels for regulatory capital (Blom, 2009). Basel I incorporated a risk-weighted approach and a two-tier capital structure. The latter means that there was base primary capital (stocks, retained earnings, general reserves, and some other items) and a second tier of limited primary capital including some types of subordinated debt. The second tier capital could not exceed half of total base capital in counting towards the capital adequacy ratio (Blom, 2009). So far there have been Basel I, Basel II and Basel III. Basel I and Basel II fixes minimum capital adequacy ratio at 8% while in 2010, the world‘s central bankers, represented collectively by the Bank of International Settlements (BIS) handed down Basel III hiked capital adequacy ratio requirement from 8% to at least 10.5% of a bank‘s risk-weighted assets (Hanke, 2013).
IMPACT OF MICRO-PRUDENTIAL INDICES ON CAPITAL ADEQUACY RATIO OF DEPOSIT MONEY BANKS IN NIGERIA