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STRATEGIES AND CONSTRAINTS TO MINIMISING RISK EXPOSURE IN NIGERIAN

BANKS. THE CASE OF LIQUIDITY.

CHAPTER ONE
INTRODUCTION
Banks are germane to economic development through the financial services they provide. Their
intermediation role can be said to be a catalyst for economic growth. The efficient and effective
performance of the banking industry over time is an index of financial stability in any nation. As
a result, a well funded Banking Sector is essential in order to maintain financial system stability
and confidence in the economy. Banks face a number of risk areas in their day to day operations.
One of such risk areas is liquidity risk. Liquidity borders on a wide range of issues including
working capital, solvency, capital adequacy and more importantly profitability especially for
banks which are the financial life-blood of any economy.
Banks are the major providers of liquidity (.).According to the theories of financial
intermediation, the two most crucial reasons for the existence of financial institutions, especially
banks, are their provision of liquidity and financial services. Regarding the provision of liquidity,
banks accept funds from depositors and extend such funds to the real sector while providing
liquidity for any withdrawal of deposits. However, the banks role in transforming short-term
deposits into long-term loans makes them inherently vulnerable to liquidity risk (Bank for
International Settlements (BIS), 2008b:1)
The Banking Sector plays an important role in the Nigerian economy. According to Soludo
(2009:23), Nigerian banks account for over 90 percent of financial system assets and dominate
the stock market. The Central Bank of Nigeria (CBN) is alive to its role as the regulator of the
banking sector which it does by it does by setting the required reserve ratio (RRR), lender of last
resort (LOLR), setting the monetary base or High powered money, moral suasion, setting of
other rates such as monetary policy rates, inter bank lending rates in addition to setting the entire
macroeconomic framework upon which the banks operate. Also, a key activity of the CBN is
liquidity management. According to the CBN Act of 1958 and its subsequent amendments, the

CBN is responsible for implementing restrictive or expansionary monetary policies in order to


achieve price stability, influence interest rates, manage the growth in credit to the domestic
economy and maintain the international value of the local currency. It manages Banking Sector
liquidity by supplying or withdrawing liquidity from the Banking Sector which it deems to be
consistent with a desired level of short-term interest rates or reserve money. It relies on the daily
assessment of the liquidity conditions in the banking system, so as to determine its liquidity
needs and thus, the volume of liquidity to inject or withdraw from the economy. ( Ibeabuchi
2007).
The recent global financial crisis of 2007 that originated from the USA that crashed financial
institutions globally necessitated the bail out ( liquidity injection) of the banking sector by
governments of major industralised countries . This highlighted the need for sound banking
sector liquidity concerns and management as well as banking sector regulation. In Nigeria,
following the 2004 BASEL committee accord on banking supervision and capital base regulation
for banks, the CBN in 2005 raised the capital requirement for banks to N25 billion from
N2billion. In addition, new prudential guidelines were set. At the end of the exercise, only 24
banks emerged out of 88. Some of the impacts of the exercise include: broadened scope of
banking operations ranging from aggressive market expansion, increased capital assets, increased
participation in the stock market, and increased investment in the petroleum and real estate
sector. Also in 2009, the CBN injected N620 billion to rescue 8 troubled banks. Five others were
given ultimatum to recapitalize (CBN, 2010).
The strategic position Nigerian banks occupy in the financial system demands adequate appraisal
of the performance of the industry especially in the light of the current global crisis as well as the
attendant restructuring of affected banks after taking into cognizance contributions of Soludo
(2009) and Aluko (2008). For instance, while Soludo (2009) attributed the causes of the global
financial crisis to pressure to raise funds and credit contraction, Aluko (2008) pointed out that it
was due to liquidity problem and the inaccessibility of the stock market to raise fresh funds.
The banking sector has always received upper attention on protection due to the vital role it plays
in an economy. The experience of many countries shows that regulation and supervision are

essential for stable and healthy financial system and that the need becomes greater as the number
and variety of financial institution increase, However, according to Short and O Driscoll Jr
(1983), economist differs on the level of government intervention in the economy, particularly
on regulation imposed on the financial intermediaries. While some believe that many regulations
are necessary in order to protect the depositors funds, other believes that the banks are over
regulated. Against this backdrop, this study seeks to investigate the exposure of nigerian banks to
liquidity risk taking into account the macronomic constraints and regulatory framework in which
they operate. The study will therefore include aggregates of banking sector liquidity variables as
well as macroeconomic variables.
STATEMENT OF THE PROBLEM
As noted by Saunders and Wilson (2001), a common feature in banking industry around the
world is the increasing number of insolvent banks. The recent global financial crisis and its
impact on the Nigerian Banking Sector has shown that CBNs daily forecasts of Banking Sector
liquidity is not sufficient in assessing the liquidity requirements of the sector as several banks
remain relatively fragile and incapable of withstanding periodic liquidity shocks. According to
Alford (2010:6) Following the special examination and during the period from December 2008
to December 2009, Nigerian banks wrote off loans equivalent to 66% of their total capital; most
of these write offs occurred in the eight banks receiving loans from the CBN. Most of the banks
also suffered panic runs and flights to safety during the period.
Regulation no doubt is needed to bring sanity into the banking sectors as well as putting it in an
internationally competitive status. The recapitalization policy as a form of reform of the banking
sector aims among others at development of more resilient, competitive and dynamic banking
systems that support and contribute positively to the growth of the economy with a core of strong
and forward looking banking institutions that are technology driven and ready to face the
challenge of liberalization and globalization. However, the banking sector reform of N25 billion
minimum capital requirement for Nigerian commercial banks could have salvaged the financial
sectors from collapsing totally in the wake of the financial crisis of 2007 2009 but its effect
was widely felt in the banking sector leading to N620 billion bailout of 8 troubled banks by the

CBN in 2009 as lender of last resort (LOLR). It is left to be seen what the future holds for the
banking industry in the wake of future external shocks such as a financial crisis.
OBJECTIVES OF THE STUDY
Banks are profit seeking organisations. In pursueing this goal of maximising shareholders
wealth, they stabilise the entire financial system by their intermediatory functions. This has led to
increased regulation of banks in Nigeria. Referring to Almeida et al (2004), Repullo (2003)
Pandey (2008) and Demirguc-Kunt. The aim of this work is to investigate the experience of the
Nigerian banking sector with respect to liquidity and profitability within the context of
macroeconomic constraints and regulation. In that light, specific questions raised include: How
severe is the liquidity risks faced by banks, how much does monetary policy affect banking
profitability in Nigeria, how much impact does money supply have on bankscapital adequacy in
Nigeria, what is the direction of regulation for the banking sector in the wake of external shocks
such as the financial crises? The structure of work is as follows: first section is the introductory
part which aims at giving a background of the study, statement of problems, objectives and the
significance of the research. Section two reviews related literatures profile of liquidity risk in
Nigerian banks. It provides a broad definition of the concept. It also provides an overview of
bank regulation- reasons for bank regulation; its pros and cons. The third section describes the
methodology for analyzing this topic. Section four analyzes results and findings. And section
five gives a summary of our findings, policy recommendation and concludes the study.
SIGNIFICANCE OF THE STUDY
In a developing country like Nigeria bank play an important and sensitive role hence their
performance directly affects the growth, efficiency and stability of the economy. Oke (2006)
opined that the relevance of banks in the economy of any nation cannot be overemphasized
because they are the cornerstones,the linchpin of the economy of a country. The banking sector
in Nigeria has been through tumultous times especially in the wake and aftermath of the financial
crisis leading to illiquidity and insolvency problems. The study would highlight the importance
of liquidity in the banking sector as well point the relevance of the banking sector to the Nigerian
economy. The findings of this work would inform economists, bank management, policy makers
and other researchers on the severity of the liquidity problem in Nigeria and the bane of

regulation on the banking sector. Furthermore this work would add to existing literature on
liquidity risk management in Nigeria.
HYPOTHESIS
The findings of this work shall be tested using the followig hypotheses stated in the null form
Ho: monetary policy rule has no impact on banking sector liquidity in Nigeria
Ho: money supply has no impact on banking sector liquidity in Nigeria
Ho: Openess of the economy has no impact on banking sector liquidity in Nigeria

CHAPTER TWO
THEORETICAL UNDERPINNING AND EMPIRICAL LITERATURE
TRENDS IN NIGERIAN BANKING SECTOR LIQUIDITY REGULATION
Banking was introduced into Nigeria in 1892 with the establishment of the African Banking
Corporation which was subsequently acquired by the Bank of British West Africa in 1894;
however, the banking system remained rudimentary with economic activities carried out either
by barter or use of commodity money. According to Adekanye (1986:21) There was no
monetary system in Nigeria before 1912 when the West African Currency Board (WACB) was
established. He added that The West African Currency Board introduced the West African
Pound to replace the variety of circulating media of exchange in these territories. WACB was
however only established to issue West African Pounds and to ensure convertibility of the West
African Pounds into English Pounds. It therefore could not control the demand for or supply of
money. In 1917, Barclays Bank DCO was established. These two banks had a virtual monopoly
on banking business up until the end of the Second World War. After the end of the Second
World War, there was an indigenous banking boom with 185 so called mushroom
banksregistered between 1947 and 1952, although most did not actually commence operations.
Most of the banks that did start operating collapsed within a few years due to a combination of
mismanagement, insider lending and inadequate capitalization. Only four of the banks set up by
local investors during the colonial period survived until independence in 1960, all with the aid of
substantial financial support from the regional governments, whose explicit policy was to
support the efforts of indigenous banks to finance local businesses. These banks were also used
to finance political activity and to channel loans to party supporters as well as the banks
directors.
The introduction of the 1952 Banking Ordinance which for the first time in Nigeria imposed
entry conditions for banks such as minimum capital requirements, and the loss of public
confidence induced by the failure of local banks, brought the indigenous banking boom to an end
by the mid 1950s (Nwankwo 1980: 45-53). For the first time, indigenous banks were required to
have a minimum paid-up capital of 12,500 while foreign banks were required to have a
minimum paid-up capital of 100,000. Banks were also required to maintain a reserve into which
a minimum of 20 percent of their annual profits had to be paid. The 1952 Banking Ordinance

was however ineffective in managing banking liquidity. Ajayi and Ojo (1981:23) identified
several defects of the 1952 Banking Ordinance. It did not make any provision for assisting banks
in need as there was no Central Bank to act as lender of last resort; banks kept cash idle as there
were limited investment avenues and also to maintain the required level of liquidity. The
Banking Ordinance of 1958 was subsequently enacted, establishing the Central Bank of Nigeria.
The 1958 Banking Ordinance raised the minimum statutory reserve from 20 percent to 25
percent of annual profits; maximum lending to any one borrower was limited to 20 percent of the
sum of paid-up capital and statutory reserves; and specified a list of acceptable liquid assets. The
1958 Banking Ordinance was amended in 1962; the amendment raised the minimum paid-up
capital of indigenous banks from 12,500 to 250,000 while foreign banks were required to
maintain a minimum of 250,000 worth of assets in Nigeria. The 1958 Banking Ordinance and
its 1962 amendment were repealed in 1969 and replaced by the Banking Act of 1969. The
Banking Act of 1969 empowered the CBN to stipulate minimum holding by banks of cash
reserves, specified liquid assets, special deposits and stabilization securities. The maximum
lending to a single borrower was also increased from 20 percent to 33.3 percent of the sum of
paid-up capital and statutory reserves. An IMF-supported Structural Adjustment Programme
(SAP) was introduced in 1986 in order to encourage competition and market-led resource
allocation. NCEMA (2003:7) explained that SAP emphasized reliance on market forces and the
private sector in dealing with the fundamental problems of the economy. The package of
financial reforms introduced during this period led directly to an increase in deposit money banks
from 40, pre-1986, to 120 in 1992. In 1990, entry into the Nigerian Banking Sector was further
liberalized as foreign banks were allowed to open offices in the country. CBN Decree 24 and the
Banks and Other Financial Institutions Decree 25 both of 1991, which repealed the Banking
Decree 1969 and all its amendments, were, thereafter, enacted to strengthen and extend the
powers of CBN to cover new institutions in order to enhance the effectiveness of monetary
policy, regulation and supervision of banks as well as non-banking financial institutions. By
1998, however, the number of deposit money banks in operation had whittled down to 89 with
the monetary authorities liquidating 30 terminally distressed deposit money banks.

By end of March 2004, although there were still 89 deposit money banks in Nigeria, 14 were
assessed as being only marginally sound, 11 unsound and 2 not rendering any returns to the
monetary authorities during the period. According to Soludo (2004:3), the problems with the
unsound deposit money banks included persistent illiquidity, poor asset quality, weak corporate
governance and gross insider abuses. The minimum capital requirement at the time was US$7.53
million for existing banks and US$15.06 million for new banks with most Nigerian banks having
a capitalization of less than US$10 million. The weak capital base of some of the ailing banks
was evidenced by their overdrawn accounts with the Central Bank of Nigeria and high incidence
of non-performing loans. Okonjo-Iweala and Osafo-Kwaako (2007:15) explained that To
strengthen the financial sector and improve availability of domestic credit to the private sector, a
bank consolidation exercise was launched in mid-2004. The Central Bank of Nigeria requested
all deposit banks to raise their minimum capital base from about US$15 million to US$192
million by the end of 2005... in the process of meeting the new capital requirements, banks raised
the equivalent of about $3 billion from domestic capital markets and attracted about $652 million
of FDI into the Nigerian banking sector. Although sufficiently capitalized, the financial crisis
which began late in 2007 showed that Nigerian depost money banks were not resilient enough to
withstand liquidity shocks and continued to rely on significant liquidity support from the
monetary authorities. According to Fadare (2011:203), Between August and December 2009 for
example, the Central Bank of Nigeria injected the equivalent of US$4.1 billion into 10 Nigerian
banks adjudged to be facing grave liquidity crisis, sacked 8 bank CEOs, introduced a plethora of
regulations and took other direct actions deemed necessary in order to safeguard the Banking
Sector from systemic collapse and to ensure the stability and soundness of Nigerias banking
sector.
By the end of the third quarter of 2009, broad money (M2) showed an increase of 5.6 per cent on
a year-on-year basis. The trend in money supply movement was a reflection of the fall in net
foreign assets and slowdown in credit to the private sector. The gross official foreign reserves
had fallen from US$54.22 billion at the end of January 2008 to US$43.34 billion as at end
September 2009. To improve liquidity and financial stability in the Nigerian banking system, the
Monetary Policy Committee of the CBN in November 2009 introduced several policy measures
including quantitative easing to bridge the gap estimated at approximately N500 billion (US$3.3

billion) between the levels of current monetary aggregates and the benchmark levels for 2009;
redemption of promissory notes issued by the monetary authorities; and the lifting of the ban on
the use of Bankers Acceptances and Commercial Papers. Despite the various policy measures
implemented by the CBN to improve Banking Sector liquidity, key economic variables
deteriorated. For example, the headline inflation rate was 12.4 percent in November 2009, up
from 11.6 and 10.4 percent recorded in October and September, 2009 respectively. Reserve
money was also below the indicative benchmarks for most of 2009 while the annualized growth
rate of private sector credit was 26.10 percent, significantly below the indicative benchmark of
45 percent. The average maximum lending rate rose to 23.1 percent in November 2009 from
22.97 percent in September 2009 while the average prime lending rate rose to 18.93 percent in
November 2009 from 18.33 percent in September 2009, In November 2009, the Wholesale
Dutch Auction average exchange rate stood at N150.85 per US dollar compared with N149.3578
per US dollar in October 2009, representing a depreciation of 1.0 percent
THE NEED FOR BANKS REGULATION
Economists have come to disagree on the level of government intervention in economic and
financial activities over the world (Adam, 2005) while some believe that many regulations are
necessary in order is interpreted to mean embarking on comprehensive process aimed at
substantially improving the financial infrastructure, strengthening the regulatory and supervisory
framework to address the issue of low capitalization and a structured financing for cheap credit
to the real sector and financial accommodation for small and rural credit schemes. Studies have
shown that the objectives of financial sector reforms are broadly the same in most countries of
sub-saharan Africa (Omoruyi 1991, CBN 2004, Balogun, 2007, Ray, 1986). These are
summarized to include market liberalization for promotion of more efficient resource allocation,
expansion of savings mobilization base, promotion of investment and growth through market
base interest rates. It also means the improvement of the regulatory and surveillance framework,
fostering healthy competition in the provision of service and above all laying the basis for
inflation control and economic growth (Balogun, 2007). The Nigeria banking reforms is a
product of global effort at revamping the world economy (Emeria and Okafor 2008) various
approaches to economic and financial reforms include the millennium development goals
(MDGs), the new partnership for Africa development (NEPAD) strategy and the national

economic empowerment and development strategies (NEEDS) that are geared towards the
economic development of the country. According to Emeria and Okafor (2008) for a long term in
the history of policy reforms in Nigeria the banking sectors was given priority attention such that
directive by means of regulation were issued to the banking sector with the aim of development
other sector and thus propelling the entire economy.
EMPIRICAL LITERARURE.
Soludo (2004) discovered that low capitalization of the banks has made them less able to finance
the economy and more prone to unethical and unprofessional practices. These include poor loan
quality of up to 21 per cent of shareholders funds compared with 12 percent in Europe and
America; overtrading, abandoning the true function of banking to focus on quick profit ventures
such as trading in forex and tilting their funding support in favor of import-export trade instead
of manufacturing; reliance on unstable public sector funds for their deposit base; forcing their
female marketing staff in unwholesome conduct to meet unjustifiable targets in deposit
mobilization; and high cost of funds. Aminu and Kola (2004) maintained that increasing the
capital base of banks in Nigeria would strengthen them and, in the process, deepen activities
within the industry. Growing the Nigerian economy is about the number of banks that have the
capacity to operate in all the states of the federation, fund agriculture and manufacturing
concerns, and in the process generate employment for Nigerians. (Ologbondiya and Aminu,
2005).
Olaniyi et al (2011) in a study on Causes and impacts of global financial crisis on the
performance of Nigerian banks using Ordinary Least Square method of Multiple Regression
found when the global financial crisis came, it destabilized the expected return of
theconsolidation exercise of 2005 which seriously affected the operation of Nigerian banks. This
study evaluatesthe causes and implications of the global financial crisis on the performance of
Nigerian banks with a view to determine the extent of this impact and determining various
options that could cushion the impact as well as avoiding future reoccurrence. The secondary
data used in this study are those relating to loans and advances, customers deposit and
investment in securities (independent variable), while the dependent variable is bank
performance. The study revealed that global financial crisis has a negative impact on the

performance of Nigerian banks despite in defiance of high liquidity possessed by these banks
immediately after the consolidation exercise of 2005. It was recommended that banks should
desist from financing other banks investment in securities to avoid multiplier effect syndrome
while the Nigerian government should find alternative ways to fund their budget deficit
Williams (2011) in a comprehensive study investigates the impact of banks characteristics,
financial structure and macroeconomic indicators on banks Capital base in the Nigerian banking
industry in Nigeria during the period 1980 2008 within an error correction framework. Cointegration technique revealed that economic indicators such as rate of inflation, real exchange
rate, demand deposits, money supply, political instability, return on investment are most robust
predictors of the determinants of capital adequacy in Nigeria. After the global credit crunch
capital adequacy, being critical for banks, led the study to examine the relationship between bank
capital base and macroeconomics variables. This implies that political stability may reduce
financial distress and bankruptcy why Foreign investment will affect Banks capital in most
developing economy in the period of financial crisis . However, the study also establishes that
there is a negative relationship between inflation and banks capital base as inflation erode banks
capital in most developing economy. This simply means that Nigerian government should
regulate investment policy why banks regulators should strive to keep inflation rate at a
minimum level, if possible below 5% for them to be more efficient so as to be globally
competitive.
Moore (2009) explained that "a bank needs to hold liquid assets to meet the cash requirements of
its customers. if the institution does not have the resources to satisfy its customers' demand, then
it either has to borrow on the inter-bank market or the central bank". It follows therefore that a
bank unable to meet its customers' demands leaves itself exposed to a run and more importantly,
a systemic lack of confidence in the banking system. Bordo et al (2001), suggest two
explanations on the cause of liquidity runs on deposit money banks. They explained that runs on
banks are a function of mob psychology or panic, such that if there is an expectation of financial
crisis and people take panic actions in anticipation of the crisis, the financial crisis becomes
inevitable. Bordo et al (2001:58) also "asserts that crises are an intrinsic part of the business
cycle and result from shocks to economic fundamentals.When the economy goes into a recession
or depression, asset returns are expected to fall. Borrowers will have difficulty repaying loans

and depositors, anticipating an increase in defaults or non-performing loans, will try to protect
their wealth by withdrawing bank deposits. Banks are caught between the illiquidity of their
assets (loans) and the liquidity of their liabilities (deposits) and may become insolvent.
In Nigeria, Uremadu and Efobi (2008), examine impact of capital structure on corporate
profitability in Nigeria using 10 manufacturing companies for 5 years (2002-2006) using
Pearsons correlation coefficient and OLS regression model on a pooled time series data. They
find that ratio of long-term debt to equity capital (gearing) has a positive and significant impact
on return on capital employed (ROCE). They recommend that company management should
properly manage composition of their capital structure more especially as it relates to long-term
debts and equities
Using a single bank, Diamond and Dybvig (1983), developed a model which showed that bank
deposit contracts can provide allocations superior to those of interbank markets, offering an
explanation of how banks subject to runs can attract deposits. Brighi (2002) however show that
abandoning the hypothesis of a single bank increases the relevance of the interbank market.
Further, the probability of a banking crisis at a single bank decreases when interbank transactions
are introduced - relative to a stand-alone bank. Indeed, Diamond and Dybvig (1983:416)
acknowledge that "if many banks were introduced into the model, then there would be a role for
liquidity risk-sharing among banks".
According to Brighi (2002), in a theoretical framework where liquidity crises are not only caused
by bank runs, and where there is uncertainty about the proportion of depositors who may want to
withdraw deposits, doing away with the assumption of an autarchic banking system decreases the
risk of bank failure as a single bank on its own would be unable to meet depositors demands.To
manage their liquidity risk and take decisions on how much cash and other liquid assets they
should hold, Agnor et al (2004:30) hypothesize that "banks internalize the fact that they can
draw funds from either the interbank market or the central bank in case of unexpected
contingencies." They added that in the event of illiquidity, banks must borrow the missing
reserves at a penalty rate; this is the opportunity cost of not holding sufficient reserves.

Oluyemi (2006) studied the effect of banking sector reforms on corporate governance and
concluded that to check abuses in the emerging consolidated banking system institutionalization
of good corporate governance practice is both necessary and desirable. Hovakimian and Kane
(2000) conducted a study that quantifies regulatory efforts to use capital requirements to control
risk-shifting by U.S. banks during 1985 to 1994 and investigates how much riskbased capital
requirements and other depositinsurance reforms improved this control. The result revealed that
capital discipline did not prevent large banks from shifting risk onto the safety net.
Raheman, Zulfiqar and Mustafa (2007) investigate effect of capital structure on the profitability
of firms listed on Islamabad Stock Exchange using Pearsons correlation coefficient and
regression analysis on 94 non-financial firms for period 1999-2004 on a pooled OLS model.
They find that capital structure has a significant effect on the profitability of these firms.
Specifically, they discover that long-term debts have negative relationship with profitability
while equity is positively correlated with profit. They therefore subscribe to a balanced financing
mix to avoid unforeseen future loses
All the above reviewed empirical studies provide us with a solid background for the study as
well as give us idea regarding liquidity risk and macroeconomic measures to mitigating against
banking sector liquidity risk. Most of the works reviewed analysed liquidity risk using
correlation analysis while others used OLS regression such as the works of Uremadu and Efobi
(2008), williams (2011), Olaniyi et al (2011) . However these studies were conducted using
selected banks and some did not take account of macroeconomic constraints. This works seeks to
fill this gap by modelling aggregates of liquidity risk variables for the entire banking sector and
macroeconomic indicators noting that monetary policy and macroeconomic disturbances affects
the entire banking sector as a unit.

CHAPTER THREE
MODEL SPECIFICATION
In order to account for the impact of macroeconomic variables on banking sector liquidity
proxied with capital adequacy in the banking sub-sector of the Nigeria economy, the model for
the study is hereby specified as follows:
CAB=f(TL,MS,DIR,INFL,DL,POL,ER,LQ,OPEN) ...(1)
The above model is hereby written in log -linear form as:
(L)CAB= bo+b1TCL(L)+b2MS(L)+b3DIR(L)+ b4INFL(L) + b5DL(L) + b6POL(L) + b7ER(L)
+b8MPR(L)+b9OPEN+t.(2)
Apriori: b1> 0, b2> 0, b3> 0, b4<0, b5> 0, b6<0, b7> 0, b8> 0, b9> 0.
Where:
CAB = CAPITAL ADEQUACY BASE
TL = TOTAL LOANS.
MS = MONEY SUPPLY
DIR = DOMESTIC INTEREST RATE (REAL)
INFL = INFLATION RATE
DL = DEMAND DEPOSIT
POL = POLITICAL INSTABILITY DUMMY = 1 MILITARY REGIME AND TURBULENT
YEARS, 0 OTHERWISE ER = EXCHANGE RATE
MPR = MONETARY POLICY RULE
OPEN = OPENNESS OF THE ECONOMY (TOTAL TRADE /GDP RATIO)
Capital adequacy being the dependent variable is the total asset of banks deflated by total
number of capitalize banks operating in the economy while the independent variables such as
demand deposit is total deposits including private and public, while others variables includes
total loans, money supply and interest rate (real), exchange rate, inflation rate (nominal), political
instability including civilian and military regime. Ut = Captures other variable not included in
the model and it takes care of other factors that cannot be observed or computed due to lack of
data. Ut is referred to as stochastic error term.

ESTIMATION TECHNIQUE
This study used ordinary Least Squares regression to get the specific impact of the independent
variables on the dependent variables in line with the objectives of the study. The choice of the
model is due to the best linear unbiased estimator (BLUE) properties of OLS that makes it the
most suitable technique for this model. The results from the model was interpreted based on
statistical, econometric and economic insight. Pre estimation tests shall include unit root and cointegration tests. However, an error correction mechanism (ECM) would be conducted if
variables are of the same order with the dependent variable thereby indicating

long run

relationship. The existence of unit root and co-integration tests the necessary and sufficient
conditions for using the error correction mechanism to bring the non-stationary trend to
equilibrium.
DATA
The study used yearly time series data of the relevant variables. The data banks employed are the
CBN statistical bulletin, National Bureau of statistics (NBS) and the securities and exchange
commission (SEC) annual Reports covering the period from 1980 to 2011 on the Nigerian
economy.

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