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Adequate capital is very important for any business, and banking is not an exception.  The importance of adequate capital in banking stems from the following functions being performed by capital, viz: capital provides a cushion for absorbing operational losses; it provides a measure of shareholders’ confidence and stake in the bank; it reveals the bank’s ability to finance its capital expenditure and fixed assets; and it provides protection to depositors’ funds, among others.  It is therefore necessary to have enough capital so that depositors’ risks could be minimized.

Government, on the advice of the monetary authorities, prescribes the minimum paid-up capital for banks.  Recently the CBN consolidated the banks by raising the Shareholders fund to N25 billion.

A bank’s capital adequacy is based on the capital ratio which involves the weighting of a bank’s capital base against the portfolio of risk assets carried.  A minimum of 10 percent of the total risk-weighted assets of a bank is required to be maintained as capital funds.  Similarly, it is required that not less than 50 percent of a bank’s capital must be Tier 1 or primary capital (that is, paid-up capital plus reserves).  In addition, the ratio of adjusted capital to loan assets of the bank should be a maximum of 1:10.  In other words, a Naira capital should support not more than N10 of loans.

Using banks’ total risk-weighted assets ratio for example, the supervisory authorities classify banks as adequately capitalized, marginally under-capitalised, significantly under-capitalised, critically under-capitalised or technically insolvent, depending on the value of their risk-weighted asset ratios.  While a bank with risk-weighted asset ratio of 10 percent and above is classified as adequately capitalized, a bank with a negative risk-weighted assets ratio is classified as technically insolvent.  This classification is an attempt at establishing bench-marks for prompt supervisory intervention.