Financial Leverage, Asset Quality, and Financial Performance: Empirical Evidence from Quoted Deposit Money Banks in Nigeria

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The study investigated the influence of financial leverage and asset quality on the financial performance of quoted deposit money banks in Nigeria: 2015-2024. Using panel data of ten systemically important banks (100 bank-year observations), we employed the Panel Generalized Least Squares and the Augmented Mean Group estimation techniques to refer to average effects and bank-specific heterogeneity, respectively. The empirical results provide evidence that financial leverage, measured by the debt-to-equity ratio, and the debt-to-assets ratio, have negative significance on return on assets (ROA), return on equity (ROE), and net interest margin (NIM). An increase in the debt-to-equity ratio by one unit negatively affects ROA by 1.93%, ROE by 1.33% and NIM by 0.09%, while the impact on NIM by the debt ratio is much more adverse at -6.19% of the increase. The adverse effects of financial leverage on NIM seem to be more severe. Asset quality, represented by non-performing loans (NPLs) and loan loss provisions, also contributes to financial performance constraints across metrics, with a one-percentage-point increase in NPLs negatively affecting ROA by 1.55% and NIM by 0.31% The overall effects demonstrate that financial leverage and asset quality combined worsen the performance of banks, as is generally accepted, and cannot be managed independently. Among the banks, heterogeneity in leverage exists, with Fidelity Bank being the most vulnerable and Sterling Bank being the most resilient. The overall results provide support for the differentiated risk-based regulatory supervision approach rather than uniformity across the entire industry. The results of the study have the potential to support capital structure decisions of bank managers, framing of regulatory capital requirements by policy makers and the assessment of banking sector quality by potential investors, among others.

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