Does Capital Adequacy Ratio moderate the Relationship between Asset Quality and financial Performance of Commercial Banks in Nigeria?

Abstract

This study examines the impact of non-performing loans (NPLs) and loan loss provisions (LLPs) on the return on equity (ROE) of commercial banks in Nigeria, while explicitly investigating the moderating role of capital adequacy proxied by the risk-adjusted capital ratio (RACR). A quantitative research design is adopted, employing a balanced panel data framework using panel regression over a ten-year period spanning 2015–2024. The sample comprises thirteen (13) deposit money banks, selected purposively due to their systemic importance and substantial contribution to Nigeria’s banking sector. Data are sourced from audited annual reports and accounts and analysed using Panel-Corrected Standard Errors (PCSE) to address heteroskedasticity, contemporaneous correlation, and panel-specific disturbances. The empirical findings reveal that non-performing loans and loan loss provisions exert a statistically significant negative effect on return on equity, indicating that deteriorating asset quality undermines bank profitability. In addition, the risk-adjusted capital ratio exhibits a significant moderating effect on the relationship between asset quality indicators and financial performance, highlighting the critical role of capital buffers in mitigating credit risk exposure. The results provide robust empirical support for the relevance of RACR as a performance and regulatory metric in banking analysis. The study recommends that banks strengthen credit risk assessment, improve loan recovery mechanisms, and maintain adequate risk-adjusted capital levels to enhance resilience and profitability. These findings offer valuable insights for bank managers, regulators, investors, and policymakers concerned with financial stability and sustainable banking performance in Nigeria and other emerging economies.