Effect of Asset Quality Regulations on Financial Performance of Deposit Money Banks in Nigeria

Abstract

This study investigates how regulations concerning asset quality of Deposit Money Banks (DMBs) affect their financial performance in Nigeria from 2015 to 2025. Concerns about the effectiveness of prudential regulations in sustaining profitability and stability have intensified due to rising non-performing loans (NPLs) and loan concentration. An Autoregressive Distributed Lag (ARDL) model is applied to data of 41 quarterly observations sourced from the Central Bank of Nigeria to explore short- and long-run dynamics between asset quality regulation—measured by loan-to-asset ratios and NPLs—and return on equity. The findings reveal no significant long-run relationship between asset quality regulation and financial performance. However, in the short run, loan-to-asset ratios exert a negative and significant effect, implying that excessive loan growth undermines profitability. Conversely, NPLs show no significant impact, suggesting that banks temporarily offset credit risks through provisioning and income diversification. The absence of long-run cointegration underscores the fragility of asset quality as a driver of sustained profitability. The study concludes that while credit expansion can yield short-term returns, it jeopardises long-term stability without robust risk management. It recommends that the Central Bank of Nigeria enforce stricter prudential guidelines, strengthen loan restructuring mechanisms, and promote proactive risk assessment to ensure sectoral resilience.