Exploring How Risk-Weighted Capital, Credit Risk and Liquidity Risk Shape Bank Performance

Abstract

This study reinforces the pivotal role of banks in fostering financial stability and economic growth. Using a balanced panel dataset of 12 banks from 2010 to 2023, it examines the impact of risk-weighted capital, credit risk, and liquidity risk on the performance of Nigerian banks. Employing Panel-Corrected Standard Errors (PCSE) and Feasible Generalized Least Squares (FGLS) estimators, the analysis reveals a consistent negative relationship between bank performance, measured by return on assets (ROA), and each of the three risk dimensions. Specifically, higher risk-weighted capital (RWC) levels are associated with reduced profitability, implying that excessive capitalization may impede revenue-generating activities. Similarly, higher credit risk, as proxied by the Z-score, and increased liquidity risk negatively impact ROA, underscoring the need for robust credit evaluation and liquidity management frameworks. Interestingly, when modeled jointly, liquidity risk exhibits a positive effect on performance, indicating that banks with robust liquidity positions may engage in profitable risk-taking. Additionally, the study reveals that larger banks tend to experience diminishing returns, likely due to inefficiencies associated with scale. These findings highlight the complex interplay between risk factors and bank performance, underscoring the need for integrated risk management strategies. The study recommends that the Central Bank of Nigeria should strengthen real-time risk monitoring systems, enforce capital and loan quality standards, promote adequate liquidity buffers, and facilitate advanced analytics training for staff development. Moreover, the study emphasizes the necessity of enhanced transparency in risk disclosures to strengthen investor confidence. These policy measures are crucial to fostering a banking industry that is resilient, effective, and stable.