CAPITAL BUDGETING PRACTICES IN QUOTED BANKS IN NIGERIA: INTRODUCTION

INTRODUCTION

Capital budgeting plays a pivotal role in any organisation’s financial management strategy. Gitman (2008) defines it as the “process of evaluating and selecting long term investments that are consistent with the business’s goal of maximising owner wealth”. Typically every organisation that embarks on this process must take all necessary steps to ensure that their decision making criteria supports the business’s strategy and enhances its competitive advantage over its rivalries. Payday Loans Online

The realisation that a business leverages its competitive advantage on its resources and on how it undertakes decisions relating to the use of its resources, such as financial resources call for managers to make informed decisions. Managers world over have developed both systematic and non-systematic ways to handling capital budgeting procedures in their organisation. In today’s highly competitive environment, managerial decisions are usually but not always based on informed research and information.

Capital budgeting practices are some of the vital inputs in the decision-making process of embarking on investment projects. A very good analysis, scrutiny, implementation and monitoring of such projects could yield the expected results for the stakeholders. According to Dayananda, Irons, Harrison, Herbohn and Rowland (2002), the capital budgeting practices are used to make investment decisions so as to increase shareholders value.

Capital budgeting is primarily concerned with sizable investments in long-term assets (Elumilade, Asaolu, and Ologunde, 2006). Capital budgeting decisions thus have a long-range impact on the strategic performance of the organization and are also critical to its success or failure. Capital budgeting plays an important role in allocating resources in enterprises. Through a well-structured process of capital budgeting done by individual divisions, an enterprise can compare the profitability of its divisions, assess the feasibility of new business proposals, decide which projects to expand, construct a corporate portfolio to maximize returns, such as return on asset (ROA), return on equity (ROE) and risk-adjusted return of capital (RAROC), and minimize risk (Wong, 2009).

In 2006, a new global regulatory standard Basel II was implemented. It requires banks to prepare sufficient capitals, mostly comprised of equity, to support their risky business. Under Basel II, capital charges are linked with three risk categories, namely market risk, credit risk and operational risk. All risk exposures are converted to risk-weighted assets.

Banks are required maintain a minimum capital adequacy ratio at 8% (i.e. Regulatory capital / Risk-weighted assets > 8%). Currently most banks follow simple methods (standardized approach or others) specified by their bank supervisors to compute capital charges. Some rely on their internal models to estimate risk levels and convert these risk estimates to capital charges with equations specified by their bank supervisors.

For all internal models, banks should have rigorous procedures to do back-testing or model validation. Basel II compliance is not simply computing right risk estimates. To maximize the use of their capitals, banks should think strategically how to allocate capitals to individual divisions and projects. An ideal scenario will be “high profit with low capital charge”.

Also, banks cannot easily grow their equity in a pace like what they can do on their asset. Therefore, banks should have an effective capital budgeting process that considers cash flows, capital charges to be required and cost of the capital charges (Basel Committee, 2006).

There had been so much debate about the current banking crisis, but less attention has been paid to the capital budgeting practices at the banks and its adverse effect on the industry. The banking industry, particularly in Nigeria, has experienced many changes in the last few years, and there are no indications the future will be different.

This movement of banks and bank holding companies into new markets and the concomitant capital expenditures will increase the potential for using a variety of capital budgeting techniques. In an effort to gauge current industry practices for capital budgeting and to find out the determinants of capital budgeting, this study was birthed. The objective of this study is to find out the determinants of capital budgeting in the Nigerian banking sector.

Using fixed assets acquisition as a proxy for capital budgets, the study build a model relating capital budget to ROA, retention ratio, profitability, growth in profitability, leverage and total assets. To the knowledge of the author, no study has examined the determinants of capital budgeting in the Nigerian Banking Sector.