Dynamics of Regulatory Capital and Bank Performance in Nigeria Using the Driscoll–Kraay and Fixed Effects-2SLS Approaches

This study examines the effect of regulatory capital requirements on bank performance in Nigeria. The study utilises panel data from the audited annual reports and accounts of 13 deposit money banks, the Central Bank of Nigeria and the Nigerian Exchange Group to investigate whether stronger capitalisation improves accounting and market-based performance. This was cross-validated with data from the World Development Indicators (WDI) from the World Bank. Market data required to compute Tobin’s Q, including market capitalisation and share prices, were gathered from the Nigerian Exchange Group (NGX). The study employs two-way fixed effects with Driscoll–Kraay standard errors and the fixed-effects–Two-Stage Least Squares (FE-2SLS) techniques to analyse panel data from 2007 to 2024 and address unobserved heterogeneity, cross-sectional dependence and endogeneity between capital and performance. Banks’ performance was measured using return on assets and Tobin’s Q, which are accounting-based and market-based performance measures. The results indicate that capital adequacy, which explains prudential requirements, significantly enhances bank performance. The FE-2SLS estimates provide consistent evidence, strengthening confidence in the relationship between capital and profitability. The study confirms that while non-performing loans and inflation negatively affect profitability, liquidity, bank size, board independence and GDP growth improve bank performance. These findings are consistent across both accounting and market-based performance measures and conclude that stronger capital can enhance bank profitability. Thus, regulators should continue to execute policies that ensure capital adequacy translates into financial performance. In addition, policymakers and bank managers should strengthen governance structures and enhance risk management strategies to improve banks’ asset quality for long-term financial performance.