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Authors

Simon A. YUNISA (Ph.D),Meshack ANYAKWU (Ph.D),Olugbenga Alao LAJORIN (Ph.D),

Abstract

This study examined the effect of leverage on the financial performance of Deposit Money Banks (DMBs) in Nigeria. It covers the period 2005-2020 and used a sample of eleven DMBs listed on the Nigerian Stock Exchange. Data used include ratio of short term debt to total assets, return on capital employed, return on asset, debt-equity ratio, interest coverage ratio, ratio of long term debt to total assets and total debt to total asset ratio. The study used the Random effect model to analyze data collected and findings showed that leverage indicators exert significant effect on the return on assets and return on capital employed of DMBs in Nigeria. The study concludes that leverage significantly affects DMBs financial performance as it enhances managerial efficiency. This is so, as managers are burdened with the payment of interest, thus, leaving few cash flows for perquisites; thus, aligning their interest with that of shareholders. The study recommended that since financial leverage decision is very critical to the survival and performance of banks, an appropriate debt-equity mix should be adopted, so as to improve their financial performance and remain competitive.

 

Keywords: Leverage, Debt equity ratio, Total debt to total asset, ROA

Full Text

1. INTRODUCTION

The degree to which a corporate body (Investor) uses borrowed funds to finance its projects is called financial leverage. Abor (2005) described it as the part of the assets of a company that has been financed by the use of debt. One of the fallouts of a firm being highly levered is the risk of becoming bankrupt if the company is not able to meet the interest obligation on the debt. Such a firm may also not be able to secure loans in future.

            Leverage, per se, should not be seen as a negative management step; because the wealth of the firms’ shareholders can be increased by the use of debt through tax advantages related to borrowing (Popoola & Suleiman, 2020). However, high financial leverage results in high finance cost which have negative effect on earnings per share. A firm that uses more debt compared to equity is seen to be highly levered (Utami, Pardanawati, & Septianingsih, 2018). This synchronization of debt and asset was required to be fulfilled in order to preserve the bank’s financing to the customer, which then leads to increased profitability.

Anarfo (2015) observed that poor capital structure decision can result in higher cost of capital and low financial performance. This increases the financial risk of the firm and might lead to illiquidity. Persistent illiquidity can result to technical distress, bankruptcy and ultimately winding up. Financial structure is the most famous among other notable decisions made by a firm as it is concerned with ascertaining the optimum capital combination for the firm. Firms at every level of development are seemingly at crossroads when faced with the options of either of debt (leverage) and equity or the combination of the two in project and operational financing (Popoola & Suleiman, 2020).

The term ‘financial leverage’ describes the capacity of an organization to use debt in its financial structure. It also means a degree of how much debt and equity a company adopts in financing its assets (Ahmed, Ningi & Dalhat, 2018). The importance of financial decision cannot be underestimated; as issues that lead to business collapse are managed using certain financial steps which can engender growth, and attainment of other corporate objectives. Studies of corporate failures in several climes have shown that financial distress is caused by sub-optimal financial decisions. And such decisions have resulted in financial structures that were not beneficial to the firm (Popoola & Suleiman, 2020).

Over time, the business of banking in Nigeria has grown and become highly
competitive. Banks are distinguished on how efficiently and competitively they
employ their resources as they constitute an important component of growth and
development of the economy. It is commonly argued that growth and stability of any
economy majorly depends on the strength or otherwise of players in the banking industry. Though, the contribution of other sectors such as insurance, mortgage, foreign exchange,
and other non-bank financial institutions cannot be over-emphasized. The bank and non-bank financial institutions serve as the link between surplus-spending and deficit-spending units in the economy. Their major role involves the facilitation of funds to productive sectors and enhancing the payment systems (Popoola & Suleiman, 2020).

Moreover, the prices of banks’ common stocks are impacted by the interplay of
debt and equity. Therefore, the choice of banks’ financial structure is quite significant.  It also portents various macroeconomic effects as it impacts on the rates of interest, economic growth and the development of the securities market. This is because the financial performance of banks shows in a measurable form, the extent to which its corporate financial objectives have been achieved. Thus, banks’ profitability depends on the effective utilization of its assets in revenue generation.

Statement of the Problem

This study examined the effect of leverage on the financial performance of Deposit Money banks in Nigeria. The justification of this study can be seen from the need to measure the effectiveness of banks in an economy over a particular period of time. Another compelling reason is that the firms’ capital budgeting decisions ultimately affect their productivity, risks and returns of shareholders. This eventually affects the firms’ market value.

Moreover, an important financing decision that firms must take is to decide the proportion of debt and equity that will constitute their capital structure. It is usually a difficult task for managers to ensure that business organizations operate on the optimal mix of equity and debt. They are in constant struggle of ensuring the adequate sources of long-term financing that will maximize the wealth of shareholders (Njeri & Kagiri, 2013). Any combination of common stock, preferred stock and debt used in financing the assets of a firm creates some level of financial risk. In other words, financial risk is directly related to the firm’s capital and financial structure/leverage (Pandey 2010).

There is an ever increasing and growing variance in performance of Deposit Money Banks with relation to financing of their operations. Thus, banks’ ability minimize risk and still remain optimally financed, constitute great challenge to their managers. The financial performance of Deposit Money Banks is a subject that has attracted a lot of attention, comments and interests from both financial experts, researchers, and the management of corporate entities (Nwana & Ivie, 2017).

Though several arguments have been raised concerning the level of debt that should be used in financing firm operation, there is still no consensus as to which of the
measures has a more significant relationship with financial performance. For
instance, Fumani and Moghadam (2015) and Dasuki (2016) showed that the
relationship between the long-term debt ratio and profitability is negative. The same
was found for short-term debt ratio. This empirical result would seem to suggest
that profitable firms use more of equity relative to debt in funding their operations. On
the contrary, Adnan, Amir, Qasim, Naveed and Wasiq (2016) as well as Akingunola, Olawale and Olaniyan (2017) among others found the relationship to be positive. An inference from their results is that debt is capable of helping managers enhance the financial performance of their firms through improved productivity and, by extension, avoidance of bankruptcy (Popoola & Suleiman, 2020). Moreover, studies carried out on leverage in Nigeria revealed that most of the research works that focused on the banking sector are quite few with contradictory results, and do not separate the component of debt into long-term and short-term to see their individual impact on financial performance. Thus, this study sought to fill the evidential gap.

The broad objective of this study is to investigate the effect of financial leverage on bank efficiency in Nigeria. Specific objectives are stated below;

1. To ascertain the effect of financial leverage on financial performance of banks in Nigeria measured by return on assets.

2. To examine the effect of financial leverage on banks’ profitability in Nigeria measured by return on capital employed.

The hypotheses for this study are stated in null forms as follows;

1. Ho: Financial leverage does not have any significant effect on the financial performance of banks in Nigeria measured by return on assets.

2. Ho: Financial leverage does not significantly affect banks’ profitability in Nigeria measured by return on capital employed.

Findings from this study are relevant to certain groups of people. They include:
Finance Managers, who benefit from it in their decision-making relating to the proper mix between debt and equity that will be of advantage to the firm; Policy Makers in crafting their economic policies; Academic Community: as it serves as a reference material for further research.

The study covers the period 2011-2020 and used a sample of eleven banks. The remaining part of the study is organized into five sections. Section two dwells on the literature review; three dwells on materials and methods, four focused on data analysis and interpretation of results; while five dwells conclusion and recommendations.

2. LITERATURE REVIEW

Leverage

Leverage refers to the extent to which firms make use of their money, borrowings (debts financing) to increase profitability and is measured by total liabilities to equity. Leverage refers to the proportion of debt to equity in the capital structure of a firm. The financing or leverage decision is a significant managerial decision because it influences the shareholder’s return and risk and the market value of the firm (Omondi & Muturi, 2013). Leverage is viewed as a result of events that determines companies' source of financing to run the business (Alkhatib, 2012). Firms that borrow large sums of money during a business recession are more likely to default to pay off their debts as they mature; they will end up with high leverage and are more likely to end up with a potential risk of bankruptcy.

Measures of Financial Leverage

Financial leverage can be measured using the banks’ debt ratio, debt to equity ratio, and interest coverage ratio. Debt Ratio (DR): Ezeamama (2010) stated that debt ratio (DR) measures the amount of the total funds provided by creditors in relation to the total assets of the firm. This is measured by the total debt to total assets and is a proxy to leverage. Debt ratio = Total debt/Total Assets. The formula is given below as the ratio of Total debt to Total Assets.

Debt to Equity Ratio: Enekwe (2012) posited that debt to equity ratio is a financial ratio indicating the relative proportion of equity and debt used to finance a company’s assets which is an indicator of the financial leverage. Nwude (2003) defines debt to equity ratio as a measure of the proportion of debt to shareholders funds (Net Worth) in the total financing of a business. The ratio indicates how much naira was raised as debt per naira of equity. Debt-equity ratio has implications for the shareholders’ dividends and risk, this affect the cost of capital and the market value of the firm (Pandey, 2010).

Interest Coverage Ratio: This measure of financial leverage is also commonly known as coverage ratio. It indicates the capacity of a firm to meet fixed financial charges. Interest: coverage ratio is a ratio that recognizes that many firms lease assets and incur long-term obligations under lease contracts for the payment of lease premium (Ezeamama, 2010). Pandey (2010) stated that it indicates the ratio of net operating income (or EBIT) to interest charges. Investors usually have an idea of financial risk of a firm by comparing the coverage ratios of similar firms with an accepted industry standard, the investors.

Banks’ Financial performance

According to Iswatia, & Anshoria (2007), performance is a function of the ability of an organization to gain and manage the resources in several different ways to develop competitive advantage. Financial performance emphasizes on variables related directly to financial report. Almajali, Alamro and Al- Soub (2012) argued that there are various measures of financial performance. For instance return on sales reveals how much a company earns in relation to its sales, return on assets explain a firm’s ability to make use of its assets and return on equity reveals what return investors take for their investments.

Company’s performance can be evaluated in three dimensions; Profitability, size and liquidity. Profit is the ultimate goal of business organisations, Deposit Money Banks inclusive. All the strategies designed and activities performed are meant to realise this grand objective. Leverage levels are likely to influence profitability since it affects the Weighted Average Cost of Capital (WACC). On a different note, profitable firms can issue debt at low rates of interest since they are seen as less risky by the creditors (Mazur, 2007). Profitability ratios include: Return on Assets, Earnings per Share, Return on Equity and Return on Capital Employed.

Bank Efficiency

Efficiency is one of the key internal factors that determine the performance of commercial banks. Efficiency is the capability of management to deploy its resources efficiently, maximize income and reduce operating costs. The efficiency of organizations is often expressed qualitatively through subjective evaluation of management systems, organizational discipline, control systems, quality of staff, and others (Ongore & Kusa, 2013). One of the ratios used to measure efficiency is the Asset turnover Ratio. Others are total asset growth, loan growth rate and earnings growth rate. The higher the ratio, the more efficient the organization is believed to be. Asset turnover Ratio: This ratio tells the revenue generated from the total assets employed. It shows how much was generated from the companies’ investment of assets.

Theoretical Review

Pecking Order Theory: The Pecking Order theory was propounded by Myers and Majluf (1984). The foundation of this theory is the supposition that information available to managers is much more than those available to investors and, as such, managers can use the asymmetry of information to determine the appropriate structure between equity and debt to finance the operations of the firm. The theory states that, ordinarily, managers display the preference of sourcing funds in the order of retained earnings, then debt, and, finally, equity financing which serves as the last resort.

 

The Trade-off theory

The Trade-Off theory proposed that a firm’s optimal debt ratio is determined by a trade-off between the costs and benefits of borrowing. This study sought to find the effects of financial leverage on firm`s financial performance whether positive (benefits), negative (costs) or neutral. The trade-off theory of capital structure is the idea that a company chooses how much debt equity finance to use by balancing the cost and benefits. The classical version of the hypothesis goes back to Kraus and Litzenberger who considered a balance between the dead-weight cost of bankruptcy and the tax saving benefits of debt (Frank & Goyal, 2011). A firm’s optimal debt ratio is determined by a trade-off between the bankruptcy cost and tax advantage of borrowing.

Empirical Review

Al-Taani (2013) also conducted a study on debt-financial performance relationship of 45 listed firms in Jordan for the period 2005-2009. Findings showed that no significant association was found between debt metrics and the metrics of financial performance metrics that were considered. Adnan, Amir, Pir, Naveed, and Wasiq (2016) investigated the impact of capital structure on profitability in the seven years between and including 2005 and 2011. The study used a sample of forty cement and automobile firms listed on the stock exchange of Pakistan. Findings showed that short-term debts have positive impact on financial performance. Similarly, Nwaolisa and Chijindu (2016) using a sample of fifteen companies in the agricultural and healthcare sectors of the Nigerian economy for twenty-one year period 1993-2013, conducted a study on leverage and firm performance. The results of the regression analysis suggested that short term debt did not impact on ROE, ROA and Net Profit before Tax.

Dasuki (2016) conducted a study on the impact of debt financing on the performance of manufacturing companies. The study used a sample of one hundred and eighty manufacturing firms listed on the Borsa Stock Exchange for the ten-year period 2004 to 2013. Findings showed that the ratio of long-term debt to total debt has negative and significant effect on financial performance (ROA), but were insignificant on ROE. Ubesie (2016) conducted a study on the impact of capital structure on the financial performance of conglomerates quoted on the floor of the Nigerian stock exchange for the five-year period 2011-2015. Findings showed that long term debt has insignificant negative effect on financial performance. Akingunola, Olawale and Olaniyan (2017) conducted a study on the impact of capital structure decisions on the financial performance of listed non- financial firms in Nigeria using twenty-two as sample size. Findings showed that both short-term debt and long-term debt had negative effects on ROA but positive effect on ROE. Ajibola, Wisdom and Qudus (2018) examined the impact of capital structure on financial performance of quoted manufacturing firms in Nigeria in the period 2005 to 2014. The study revealed a statistically insignificant effect of short-term debt ratio on ROE and ROA. This was similar to the findings of Nwude and Anyalechi (2018) which focused on the impact of financing mix on the performance of DMBs.

Abdulkarim, Ahmadu, and Sulaiman (2019) conducted a study on the impact of financial leverage on financial performance of quoted agricultural firms in Nigeria for period 2005-2017. Findings showed that long-term debt ratio had significant impact on the profitability of the sampled firms. The study concluded that long-term debt may not be ideal as a source of funding for firms in Nigeria’s agricultural sector. Enekwe, Agu and Eziedo (2014) examined the effect of financial leverage on financial performance of the Nigeria pharmaceutical companies. The study covers the period of twelve (12) years (2001-2012) for three companies. The results of the analysis showed that debt ratio (DR) and debt-equity ratio (DER) have negative relationship with Return on Assets (ROA) while interest coverage ratio (ICR) has a positive relationship with Return on Assets (ROA) in Nigeria pharmaceutical industry.

In Nigeria, studies conducted in this area have also shown mixed results. Though, very few studies focused on the banking sector, as more of the studies used non-banking institutions. For instance, studies by Ubesie (2016), Akingunola, Olawale and Olaniyan (2017) and, Enekwe, Agu and Eziedo (2014) focusing on Non-banking institutions found negative relationship between leverage (debt financing) and the financial performance of institutions used as sample. While studies by Uwalomwa and UAdiale (2012), and Abdulkarim, Ahmadu and Sulaimon (2019) showed positive effect, studies by Ajibola, Wisdom and Qudus (2018) and, Nwude and Anyalechi (2018) stated no significant relationship.            

For those few studies known to the author which have used Deposit Money Banks listed on the Nigerian Stock exchange as sample, their findings also showed mixed results. For instance, study by Thaddeus and Chigbu (2012) showed mixed results. Some of the banks’ data showed that leverage impact positively on ROA, while other banks’ data showed negative effect. While similar work done by Abubakar (2015) concluded that there is no significant relationship, the study conducted by Wabwile, Chitiavi, Alala and Douglas (2014) showed negative relationship.  

From the summary above, it can be inferred that the debate on the effect of leverage on bank efficiency has remained inconclusive. This statement can be justified since findings revealed the existence of evidential gap. This study sought to contribute to literature on subject matter separating debts into short and long term to see their individual effects on bank efficiency in Nigeria.   

 

3. MATERIALS AND METHODS

The study used the ex post facto research design technique. The ex-post facto research design seeks to retrieve and study data for events which have already occurred. It is also known as “after the fact” research design because it is a method in which groups that already exist are compared on some dependent variables. Testing the reliability and validity of the data was deemed unnecessary since the data has been published and thus seen as certified by external auditors.

The population of the study consists of the twenty-five banks that survived the recapitalization exercise in 2005; thus, the justification for the study period (2005-2020).
From the population size of twenty-five banks, eleven were selected to form the study’s sample. The author decides to use banks which have traded consistently within the period of covered by the study, having available data on their websites. Secondary data were principally used and were sourced from the Annual Reports and Accounts of eleven Deposit Money Banks listed on the Nigerian Stock Exchange.

Model Specification

The study adopted the model built by Popoola and Suleiman (2020) but was modified in line with the hypotheses to be tested. The model for the study is specified as follows:
Model 1

ROA_i,t. = β₀ + β₁STD_i,t. + β₂DER_i,t. + β₃ICR_i,t + β₄TDTAR_i,t + β₅LTD_i,t + ε_i,t

Model 2

ROCE_i,t. = α₀ + α₁STD_i,t. + α₂DER_i,t. + α₃ICR_i,t + α ₄TDTAR_i,t + α₅LTD_i,t + μ_i,t

Where: ROA = Return on assets, ROCE = Return on capital employed, DER = Debt Equity Ratio an independent variable, Interest Cover Ratio, TDTAR = Total Debt to Total Asset ratio an independent variable. STD = Short Term Debt, LTD = Long Term Debt, β₀ = the intercept, β₁, … β₆ = the parameters to be estimated in the equation, i = Individual banks’ data, t = Time subscript, e = Stochastic error term

 

4. DATA ANALYSIS AND INTERPRETATION OF RESULTS

The Unit Root test is conducted to ensure that the panel data used is stationary. This is to avoid bias and inconsistent where the series is not stationary. The study used the Levin-Lin-Chu test, and the results are presented in table 4.1.

TABLE 4.1: UNIT ROOT RESULT FOR THE SPECIFIED VARIABLES USING

THE LEVIN, LIN AND CHU TEST

Variable	t –Statistics	P-Value
Roa	(-7.7682)*	0.000
Roce	(-6.3272)*	0.000
Cr	(-7.7089)*	0.000
Rstdta	(-2.3655)*	0.000
Der	(-5.9355)*	0.000
Rtdta	(-7.7436)*	0.000
Icr	(-10.9928)*	0.000
Rltdta	(-4.4722)*	0.000

Note: The Unit Root test was conducted using LLC technique under the assumption of determining the trend and intercept. The specified variables are: return on assets (roa), return on capital employed (roce), current ratio (cr) ratio of short term debt to total assets (rstdta), debt to equity (der),ratio of total debt to total asset (rtdta), interest cover ratio(icr), ratio of long term debt to total assets (rltdta).  * = Implies significant at 1%. 

Source: Field Survey, 2022.

The results of the Unit Root test showed the LLC statistics with their corresponding P-values. Result showed that the probability value in reference to each variable is smaller than the alpha value at 1%. Thus, the null hypothesis that the panel contains a unit root is rejected at 1% level of significance. Thus, all the specified variables are I (1) variables (i.e integrated to order 1). Therefore, based on the Unit Root test, our specified variables would yield plausible regression output.

Hypothesis Testing

Relationship between Leverage Indicators and Return on Assets of DMBS in Nigeria.

Based on the nature of study and the data set, panel data regression models (The Fixed effect and Random effect Models) were estimated to observe the effect of the explanatory variables on banks’ financial performance (proxied by Returns on Assets, Capital employed and Current ratio). The first section of the regression analysis involved the specification of a fixed effect model to examine for temporally constant individual-level effects. In the second enquiry, the variation across entities is assumed to be random and uncorrelated with the predictors; hence, a random effect model was specified (See Appendix B for LM results). The purpose was to find out if the effect of leverage would vary or not based on the assumptions adopted; whilst checking for the model that best fits the dataset. The empirical results are reported in table 4.2.

Table 4.2 Fixed Effects and Random Effects   Estimates: dep. Variable=ROA

Source: Authors Computation (2022)

The result on the effect of leverage on banks’ financial performance model estimation in table 4.2 showed the significance of the F- test, F (0.000) = 28.77 and F (0.000) = 98.16 in both the fixed effects and the random effects estimate and the probability values are less than 5% significance level. This implies that both fixed and random effects models are robust and fits the data well. Meanwhile, the R-squared coefficients in both estimates showed that independent variables explain about 31.17% and 36.6% of the total variance in return on assets in fixed effects and random effects estimates respectively.

From the individual effect of the explanatory variables on return on assets of deposit money banks in Nigeria, the results revealed that debt-equity ratio (DER) and ratio of long term to total assets (RLTDTA) have positive and significant effect on ROA in Nigeria; in the fixed effects (β = 0.0047, n = 176, p=0.0000 and β = 0.1664, n = 176, p=0.0000) and random effect (β = 0.0031, n = 176, p=0. 0.0000 and β = 0.0983, n = 176, p=0.0060) estimates. The result implies that on the average, holding other variables constant, a percentage changes in DER and RLTDTA will elicit changes in ROA to the tune of 9.8% and 16.6% respectively.

Moreover, ratio of total debt to total asset (RTDTA) and Interest Cover Ratio (ICR) have negative and significant effect on ROA in fixed effect (β = -0.3059, n = 176, p=0.0000 and β = -0.0076, n = 176, p=0.0036) and random effect (β = -0.3570, n = 176, p=0.0000 and β = -0.0021, n = 176, p=0.509 ) estimates. This implies that on the average, holding other variables constant, a percentage changes in RTDTA and ICR will elicit changes in ROA to the tune of 30.6% and 0.7% respectively.

The result also indicated that the RSTDTA has a negative but insignificant effect on ROA in the fixed effect (β = -0.046,  n = 176, p=0.261) and random effect (-0.048, n = 176, p=0.249) estimates.  Implying that on the average, a percent increase in RSTDTA will not elicit changes in ROA. The estimated amount of the inter-class correlation coefficient, rho, and the significance of its F-test showed that differences in the deposit money banks accounts for 19.63% and 21.84% in total variance with a prob. value of 0.0000 in both models. It would therefore not be erroneous to assume that differences across entities (firms) exact influence on ROA of deposit money banks in Nigeria. Hence, estimates from the random-effects model is examined as a fully efficient specification of the random effects under the assumption of random and normal distribution.

Relationship between Leverage Indicators and Return on Capital employed of DMBS in Nigeria.

 

Table 4.3 Fixed Effects and Random Effects   Estimates: dep. Variable=ROCE

Source: Authors Computation (2022)

The result on the effect of leverage on banks’ financial performance model estimation in table 4.3 showed the significance of the F- test, F (0.000) = 3.46 and F (0.000) = 3.43 in both the fixed effects and the random effects estimate and the probability values are less than 5% significance level. This implies that both fixed and random effects models are robust and fits the data well. Meanwhile, the R-squared coefficients in both estimates showed that independent variables explain about 7.49% and 13.29% of the total variance in return on capital employed in fixed effects and random effects estimates respectively.

From the individual effect of the explanatory variables on return on capital employed of deposit money banks in Nigeria, the results revealed that ratio of short term to total assets (RSTDTA), debt-equity ratio (DER), interest cover ratio (ICR) and ratio of long term to total assets (RLTDTA) have negative effect on ROCE in Nigeria; in the fixed effects model. However, only RLTDTA has significant effect. The result implies that on the average, holding other variables constant, a percentage changes in RLTDTA will elicit changes in ROCE to the tune of 69.1%  (β = -0.6917, n = 176, p=0.0010). Moreover, total debt to total asset has positive and significant effect on ROCE in fixed effect (β = 0.4345, n = 176, p=0.0053) estimates. This implies that on the average, holding other variables constant, a percentage changes in RTDTA will elicit changes in ROCE to the tune of 43.45%.

Similarly, in the Random effect estimates, RSTDTA, ICR, and RLTDTA, all have significant negative effect on ROCE of DMBs in Nigeria. This implies that on the average, holding other variables constant, a percentage changes in RSTDTA, ICR, and RLTDTA, will elicit changes in ROCE to the tune of 38.69%, 4.68%, and 50.7% respectively. Moreover, total debt to total asset has positive and significant effect on ROCE in random effect (β = 0.6640, n = 176, p=0.0020) estimates. This implies that on the average, holding other variables constant, a percentage changes in RTDTA will elicit changes in ROCE to the tune of 66.4%. 

The result also indicated that the DER has a negative but insignificant effect on ROCE in the Random effect (β = -0.0017,  n = 176, p=0.692) estimates.  Implying that on the average, a percent increase in DER will not elicit changes in ROCE. The estimated amount of the interclass correlation coefficient, rho, and the significance of its F-test showed that differences in the deposit money banks accounts for 23.4% and 2.53% in total variance with a prob. value of 0.0000 in both models. It would therefore not be erroneous to assume that differences across entities (firms) exact influence on ROCE of deposit money banks in Nigeria. Hence, estimates from the random-effects model is examined as a fully efficient specification of the random effects under the assumption of random and normal distribution.

Hausman Test- Fixed Effects vs Random Effects

The estimation of the Hausman test helps to determine a better efficient model between fixed effects and random effects estimates in the three models for further analysis. The results are showed that the Random effect estimate is more a more efficient model in both equations (See Apendix B.). The Hausman test result shows a chi square value of (chi2 (3) = 3.876083; p > 5%) in leverage model, supports the choice of the random effect estimates. Since, the null hypothesis of random effects is not rejected (p>0.05), the study therefore, selects the coefficients of the random effect estimates as efficient and better (Gujarati (2005 p.651).

 

Post Estimation Test

Post estimation was also conducted to determine the reliability of the study. Coefficient significance test using Wald test was conducted to ensure that the model explanatory variables are significant. The result in presented in table 4.5.

Table 4.4: Wald Test

	Test Statistic	Value	df	Probability
Leverage	F-statistic	26.8226	(2, 176)	0.0000
	Chi-square	93.717	2	0.0000

Source: Authors computation (2022)

Table 4.5 showed the result of Wald Test. Both the F-distribution and the Chi-Square distribution indicate that the independent variables (RSTDTA, DER, TDTA, ICR and RLTDTA are jointly significant to influence the dependent variables (ROA, and ROCE). Since their corresponding P-values are less than 5%. Thus, the null hypothesis is rejected and concludes that the explanatory variables (Leverage) have significant relationship with banks’ financial performance in Nigeria.

 

 

Discussion of Results

The first hypothesis sought to examine whether leverage indicators significantly influence return on asset of deposit money bank in Nigeria. Findings showed that debt ratio exert significant influence on roa. This result supports Nwude and Anyalechi (2018), Abdulkarim, Ahmadu and Sulaiman (2019). The implication of this finding is that leverage enhances bank finance performance in Nigeria.

The second hypothesis sought to evaluate whether leverage indicators significantly influence return on capital employed of DMBs in Nigeria. Result showed that both leverage indicators significantly exert influence on roce of DMBs in Nigeria. This result supports Ubesie (2016), Akingunola, Olawale, and Olaniyan (2017). The implication of this finding is that leverage enhances bank finance performance in Nigeria.

5. CONCLUSION

The study examined the effect of leverage on the financial performance of DMBs in Nigeria. The concession among researchers is that leverage impacts on bank performance but the level of usage has become subject of debate which empirical findings have not been able to proffer. There have been assertions that excess usage of leverage will portend negative effects and probably lead to financial risk.

The study concludes that the ratio of short term debt to total assets, debt equity ratio, total debt to total asset ratio, interest cover ratio and the ratio of long term debt to total assets used as leverage indicators have significant effect on banks’ financial performance in Nigeria. The study established that total debt to total asset, Long term debt ratio and Debt equity ratio are positive drive to banks’ financial performance in Nigeria.

 

6. RECOMMENDATIONS

The study suggested the following recommendations based on the findings: First, that since financial leverage decision is very critical to the survival and performance of banks, an appropriate debt-equity mix should be explored and adopted; so that they can improve their financial performance, and remain competitive.

Second, DMBs should avoid over-reliance on debt, as increase in the proportion of
debt in the capital structure increases the risk of financial distress. The recapitalization exercise as seen in 2005, should be a continuous exercise to increase the stakes of shareholders.

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