The Incentive Effect of Regulatory Capitals Requirement: Empirical Evidence from Nigeria

The divergence of opinion between policy makers and academic researchers, as to which of the first two capital requirements (Tier 1 and 2 capitals)exerts more influence on the attitude of banks towards risk, has led to an unending debate. Policy maker‟s opinethat Tier 2 capital does not satisfy the purpose with which it was introduced as compared to Tier 1capital. They are of the view that Tier 2 capital is inferior to Tier 1, both in terms of „going-concern‟ and „gone-concern‟. This group suggests that Tier 2 should in its entirety be scrapped. The academic literature, on the other hand, highlights the benefits of Tier 2 to include a device of market discipline and a signal of banks creditworthiness, thus strongly advocatesits enforcement. This study contributes to this debate by examining empirically, the relationship between these two regulatory capital requirement and banks behaviour in Nigeria. The study applies Autoregressive Distributed Lag Approach otherwise known as “Bound Testing Approach†to determine both short and long-run relationships among regulatory capitals and variables surrogating risk taking behaviour of banks. The result demonstrates the critical position of Tier 1 capital in key decision making process, in relation to credit creation and loan loss provisioning. Without assigning any role to Tier 2 capital, the result further suggests that, besides Tier 1 capital, monetary policy rate plays a striking role in the determination of loan growth. This, therefore, support the submission that Tier 1 is superior to Tier 2 at-least in terms of going-concern.