THE IMPACT OF FINANCE LEASE ON THE PERFORMANCE OF NIGERIAN BANKS

CHAPTER ONE: INTRODUCTION

1.1 Background of the Study

A finance lease (also known as a capital lease) is a lease arrangement that transfers substantially all the risks and rewards incidental to ownership of an asset from the lessor (the owner of the asset) to the lessee (the user of the asset). Under a finance lease, the lessee records the leased asset as an asset on its balance sheet and recognizes a corresponding liability for the future lease payments. This is in contrast to an operating lease, where the leased asset remains on the lessor’s balance sheet, and the lessee records only the periodic lease payments as rent expense. The classification of a lease as a finance lease or an operating lease depends on criteria such as transfer of ownership, bargain purchase option, lease term relative to asset life, and present value of lease payments relative to asset fair value (IFRS Foundation, 2021; Kieso, Weygandt, and Warfield, 2019).

The distinction between finance leases and operating leases has significant implications for financial reporting. Under finance lease accounting: (a) the lessee recognizes a right-of-use asset and a lease liability on the balance sheet, (b) the asset is depreciated over its useful life, (c) the liability is reduced as lease payments are made, and (d) interest expense is recognized on the lease liability. Under operating lease accounting, only the periodic lease payment is recognized as rent expense, with no balance sheet recognition. The accounting treatment affects key financial ratios, including debt-to-equity ratio, return on assets, asset turnover, and interest coverage, which are used by investors, creditors, and regulators to assess bank performance (IASB, 2018; Penman, 2018).

In the banking industry, finance leases are commonly used for acquiring capital-intensive assets such as land and buildings (bank branches), vehicles (fleet), information technology equipment (servers, computers), office equipment, and other fixed assets. Banks may also act as lessors, providing finance leases to customers (e.g., equipment leasing, vehicle leasing) as a form of financing. For Nigerian banks, finance leasing activities are significant, particularly for customer financing and for acquiring their own fixed assets. The adoption of IFRS 16 (Leases) in Nigeria, effective from 2019, has changed lease accounting for lessees, eliminating the distinction between finance and operating leases for lessees and requiring all leases (with limited exceptions) to be recognized on the balance sheet (IFRS Foundation, 2021; Okafor and Udeh, 2020).

The performance of Nigerian banks is typically measured using key financial metrics: (a) profitability – return on assets (ROA), return on equity (ROE), net interest margin (NIM), profit margins, (b) liquidity – current ratio, quick ratio, loan-to-deposit ratio, (c) solvency – capital adequacy ratio (CAR), debt-to-equity ratio, (d) efficiency – cost-to-income ratio, asset turnover, and (e) asset quality – non-performing loan (NPL) ratio. Finance leasing affects these performance metrics through several channels: (a) recognition of lease assets and liabilities affects the balance sheet (total assets, total liabilities, equity), (b) depreciation and interest expenses affect the income statement (profitability), (c) lease liabilities affect leverage ratios (debt-to-equity, capital adequacy), and (d) lease payments affect cash flow (operating vs. financing activities) (Brigham and Ehrhardt, 2017; Rose and Hudgins, 2018).

The adoption of IFRS 16 (Leases) in 2019 significantly changed lease accounting for Nigerian banks. Under IFRS 16, lessees are no longer required to classify leases as finance or operating; instead, all leases (with limited exceptions for short-term and low-value leases) are recognized on the balance sheet as right-of-use assets and lease liabilities. This has brought many previously off-balance-sheet operating leases onto the balance sheet, increasing reported assets and liabilities. For Nigerian banks, this has affected key ratios such as debt-to-equity (increased), return on assets (decreased, as assets increased without immediate profit increase), and asset turnover (decreased). Understanding the impact of finance leases (and lease accounting generally) on bank performance is essential for management, investors, and regulators (IFRS Foundation, 2021; Okafor and Udeh, 2021).

Prior to IFRS 16, Nigerian banks followed IAS 17 (Leases), which distinguished between finance leases and operating leases. Under IAS 17, finance leases were recognized on the balance sheet, while operating leases remained off-balance-sheet. This created opportunities for “off-balance-sheet financing,” where banks could acquire assets through operating leases without recording the associated liabilities, understating leverage and overstating profitability ratios (return on assets). The transition to IFRS 16 eliminated this off-balance-sheet financing opportunity, providing more transparent information about lease obligations (IASB, 2018; Kieso et al., 2019).

The banking industry in Nigeria is regulated by the Central Bank of Nigeria (CBN), which sets prudential guidelines for capital adequacy, asset classification, provisioning, and financial reporting. The CBN requires banks to comply with IFRS for financial reporting. The CBN also monitors bank performance through quarterly and annual returns, including key ratios such as capital adequacy ratio (CAR), non-performing loan (NPL) ratio, and return on assets (ROA). The impact of finance leases on these ratios is therefore of regulatory interest. For example, the recognition of lease liabilities increases total liabilities, which can reduce the capital adequacy ratio (CAR) unless offset by increased equity (CBN, 2020; Adebayo and Oyedokun, 2019).

The relationship between finance leasing and bank profitability can be analyzed through several mechanisms. On the lessee side (bank as lessee): (a) acquiring assets through finance leases allows the bank to use assets without large upfront cash outlays, preserving liquidity, (b) depreciation and interest expenses reduce reported profit, (c) lease liabilities increase leverage, potentially increasing financial risk, (d) the return on assets (ROA) may decrease as assets increase without immediate profit increase, (e) interest coverage ratios may be affected. On the lessor side (bank as lessor): (a) finance leases generate interest income over the lease term, (b) the lease receivable (present value of future lease payments) is recorded as an asset, (c) credit risk (default by lessee) affects asset quality, (d) profit from leasing activities contributes to overall profitability (Rose and Hudgins, 2018; Okafor and Udeh, 2020).

For Nigerian banks, finance lease transactions are common in several areas: (a) branch expansion – banks acquire land and buildings for new branches through finance leases, (b) information technology – banks lease servers, computers, and software through finance leases, (c) vehicle fleet – banks lease vehicles for their operations (cash-in-transit, staff transportation), (d) equipment – banks lease ATMs, security equipment, office furniture, and other assets, (e) customer leasing – banks provide finance leases to customers for equipment, vehicles, or other assets as an alternative to traditional loans (CBN, 2020; Nwankwo and Okeke, 2021).

The capital adequacy ratio (CAR) is a key regulatory metric for banks, defined as (Tier 1 Capital + Tier 2 Capital) ÷ Risk-Weighted Assets. The CBN requires Nigerian banks to maintain a minimum CAR of 10% for national banks and 15% for banks with international authorization. Finance leases affect CAR in two ways: (a) lease liabilities are recorded as debt, which does not directly affect regulatory capital but affects risk-weighted assets (if lease liabilities are considered in risk-weighted asset calculation), (b) right-of-use assets are included in total assets, and risk-weighted assets may increase depending on the risk weight assigned to these assets. Banks with significant finance lease obligations may see their CAR reduced, potentially approaching regulatory minimums (CBN, 2020; Okafor and Udeh, 2021).

Return on assets (ROA) = Net Profit ÷ Total Assets. Under finance lease accounting, both the numerator (net profit) and denominator (total assets) are affected. Depreciation and interest expenses reduce net profit; the recognition of right-of-use assets increases total assets. The net effect on ROA depends on the magnitude of these changes relative to the bank’s profitability. For banks with high lease volumes, ROA may decline, which could be perceived negatively by investors and analysts. However, the lease may enable the bank to generate additional revenue (e.g., through branch expansion) that partially offsets the expense (Penman, 2018; Brigham and Ehrhardt, 2017).

Return on equity (ROE) = Net Profit ÷ Shareholders’ Equity. Finance leases affect ROE through the same numerator effect (depreciation and interest reduce profit) but have no direct effect on equity (unless lease liabilities are restructured as equity, which is unlikely). Therefore, ROE may decline more than ROA because the denominator (equity) is unchanged while profit decreases. This could affect shareholder returns and the bank’s cost of equity (Ross, Westerfield, and Jordan, 2019).

The debt-to-equity ratio = Total Liabilities ÷ Shareholders’ Equity. Finance leases increase total liabilities (lease liability), increasing the debt-to-equity ratio. A higher debt-to-equity ratio indicates greater financial leverage and higher financial risk. This may affect the bank’s credit rating, cost of borrowing, and ability to raise additional debt. For banks already near their debt covenants or regulatory limits, significant lease liabilities could be problematic (Rose and Hudgins, 2018).

The cost-to-income ratio = Operating Expenses ÷ Operating Income. Finance leases affect both numerator and denominator. Depreciation (part of operating expenses) and interest expense (financing cost, sometimes excluded from operating expenses depending on presentation) affect the numerator. The leased asset may generate additional income (e.g., a new branch generates customer deposits and fee income), affecting the denominator. The net effect on cost-to-income ratio depends on the efficiency of the leased asset (Okafor and Udeh, 2020).

The impact of IFRS 16 on Nigerian bank performance has been studied, but empirical evidence is limited. Some studies suggest that IFRS 16 adoption increased reported assets and liabilities for banks, reduced ROA and ROE, and increased debt-to-equity ratios. However, the economic impact (underlying business performance) was unchanged; only the accounting presentation changed. For investors and analysts, understanding the adjustments required to compare pre-IFRS 16 and post-IFRS 16 financial statements is essential. For management, the choice between leasing and buying assets may be influenced by the accounting treatment, as leasing no longer provides off-balance-sheet financing benefits (Adebayo and Oyedokun, 2020; Okafor and Udeh, 2021).

Finally, this study focuses on Nigerian banks as a case study because the banking industry is a major user of finance leases (both as lessee and lessor) and is subject to significant regulatory scrutiny. By examining the impact of finance leases on bank performance, the study can provide insights applicable to other industries and jurisdictions. The findings will contribute to the literature on lease accounting and bank performance, inform management decisions on leasing vs. buying, and support regulatory policy (Yin, 2018; Creswell and Creswell, 2018).

1.2 Statement of the Problem

Nigerian banks are significant users of finance leases for acquiring fixed assets (land, buildings, vehicles, IT equipment) and for providing lease financing to customers. The accounting treatment of finance leases has changed significantly with the adoption of IFRS 16 (Leases) in 2019, which brought many leases onto the balance sheet. These changes affect key financial metrics used to assess bank performance, including return on assets (ROA), return on equity (ROE), debt-to-equity ratio, capital adequacy ratio (CAR), and cost-to-income ratio. However, the extent and magnitude of the impact of finance leases on bank performance in Nigeria are not well understood. There is evidence that banks with significant lease obligations may have lower ROA, higher leverage, and potentially reduced CAR. Investors, analysts, and regulators may not fully account for the effects of finance leases when assessing bank performance, leading to misinterpretation. Furthermore, the impact may vary across banks depending on their lease portfolio size, mix of finance vs. operating leases (pre-IFRS 16), and capital structure. There is a lack of recent, systematic, empirical research that examines the impact of finance leases on the performance of Nigerian banks. Therefore, this study is motivated to investigate the impact of finance lease on the performance of Nigerian banks.

1.3 Objectives of the Study

The specific objectives of this study are to:

1. Examine the finance lease practices (as lessee and as lessor) of Nigerian banks, including the volume, types of assets leased, and lease terms.
2. Assess the impact of finance leases on key bank performance metrics (return on assets ROA, return on equity ROE, debt-to-equity ratio, capital adequacy ratio CAR, cost-to-income ratio) for Nigerian banks.
3. Compare the performance of banks with high finance lease portfolios versus banks with low finance lease portfolios.
4. Evaluate the impact of IFRS 16 adoption on the financial statements and performance metrics of Nigerian banks (pre-IFRS 16 vs. post-IFRS 16).
5. Propose recommendations for bank management, investors, and regulators on interpreting and managing the impact of finance leases on bank performance.

1.4 Research Questions

The following research questions guide this study:

1. What are the finance lease practices (as lessee and as lessor) of Nigerian banks, including the volume, types of assets leased, and lease terms?
2. What is the impact of finance leases on key bank performance metrics (return on assets ROA, return on equity ROE, debt-to-equity ratio, capital adequacy ratio CAR, cost-to-income ratio) for Nigerian banks?
3. Is there a significant difference in performance between banks with high finance lease portfolios and banks with low finance lease portfolios?
4. What is the impact of IFRS 16 adoption on the financial statements and performance metrics of Nigerian banks (pre-IFRS 16 vs. post-IFRS 16)?
5. What recommendations can be made to bank management, investors, and regulators on interpreting and managing the impact of finance leases on bank performance?

1.5 Research Hypotheses

The following hypotheses are formulated in null (H₀) and alternative (H₁) forms:

Hypothesis One

• H₀: Finance leases have no significant impact on the return on assets (ROA) of Nigerian banks.
• H₁: Finance leases have a significant impact on the return on assets (ROA) of Nigerian banks.

Hypothesis Two

• H₀: There is no significant relationship between finance lease liabilities and the debt-to-equity ratio of Nigerian banks.
• H₁: There is a significant relationship between finance lease liabilities and the debt-to-equity ratio of Nigerian banks.

Hypothesis Three

• H₀: The adoption of IFRS 16 has no significant impact on the capital adequacy ratio (CAR) of Nigerian banks.
• H₁: The adoption of IFRS 16 has a significant impact on the capital adequacy ratio (CAR) of Nigerian banks.

Hypothesis Four

• H₀: There is no significant difference in return on equity (ROE) between banks with high finance lease portfolios and banks with low finance lease portfolios.
• H₁: There is a significant difference in return on equity (ROE) between banks with high finance lease portfolios and banks with low finance lease portfolios.

1.6 Significance of the Study

This study is significant for several stakeholders. First, bank management will benefit from understanding how finance leases affect their reported financial performance and key ratios, enabling them to make informed decisions about leasing vs. buying assets, manage lease portfolios effectively, and communicate with investors and regulators. Second, investors and financial analysts will gain insights into how to interpret bank financial statements that include finance leases, enabling more accurate valuation and comparison across banks. Third, the Central Bank of Nigeria (CBN) will benefit from understanding the impact of finance leases on capital adequacy ratios (CAR) and other regulatory metrics, informing prudential guidelines and stress testing. Fourth, the Financial Reporting Council of Nigeria (FRCN) will gain insights into the implementation of IFRS 16 in the banking sector, informing future standards and guidance. Fifth, auditors will benefit from understanding the materiality of finance leases in Nigerian banks, informing audit planning and procedures. Sixth, academics and researchers in accounting, finance, and banking will benefit from the study’s contribution to the literature on lease accounting and bank performance in the Nigerian context. Seventh, professional bodies (ICAN, ANAN, CIBN) will find value in the study’s identification of finance lease impacts, informing training and CPD programs. Eighth, lease finance companies and equipment lessors will benefit from understanding how their products affect bank customers’ financial statements. Finally, the broader Nigerian financial system will benefit as improved understanding of finance lease impacts leads to better risk management, more transparent financial reporting, and more efficient capital allocation.

1.7 Scope of the Study

This study focuses on the impact of finance lease on the performance of Nigerian banks. Geographically, the research is limited to commercial banks operating in Nigeria. The study covers a sample of Nigerian banks (including Tier 1 and Tier 2 banks) for which financial data is available. Content-wise, the study examines the following areas: finance lease practices (as lessee and as lessor), including volume of lease assets and liabilities, types of assets leased, lease terms, and interest rates; bank performance metrics (return on assets ROA, return on equity ROE, debt-to-equity ratio, capital adequacy ratio CAR, cost-to-income ratio, non-performing loan ratio); comparison of pre-IFRS 16 (2016-2018) and post-IFRS 16 (2019-2023) financial statements; and impact of lease size on performance metrics. The study analyzes secondary data from bank annual reports, financial statements, and regulatory filings. The time frame for data collection is the period 2016-2023 (pre- and post-IFRS 16). The study does not cover microfinance banks, development banks, or non-bank financial institutions, nor does it cover the operational aspects of lease transactions (e.g., risk management, default rates), nor does it cover the tax implications of finance leases.

1.8 Plan of the Study

This study is organized into five chapters.

Chapter One: Introduction provides the background, statement of the problem, objectives of the study, research questions, research hypotheses, significance of the study, scope of the study, and the plan of the study.

Chapter Two: Literature Review reviews relevant literature on finance leases, lease accounting standards (IAS 17 and IFRS 16), bank performance measurement, the relationship between leasing and bank financial metrics, and previous empirical studies on the impact of leases on financial statements. It also presents the theoretical framework underpinning the study.

Chapter Three: Research Methodology describes the research design, population and sample of Nigerian banks, sources of data (secondary data from annual reports, financial statements, and regulatory filings), data collection procedures, variables (independent variables: finance lease assets/liabilities; dependent variables: ROA, ROE, debt-to-equity, CAR, cost-to-income), and data analysis techniques (descriptive statistics, correlation analysis, regression analysis, and pre-post IFRS 16 comparison tests).

Chapter Four: Data Analysis and Results presents the analysis of the collected data, including descriptive statistics, correlation results, regression results, hypothesis testing, and interpretation of findings.

Chapter Five: Summary, Conclusions, and Recommendations summarizes the key findings, draws conclusions, discusses implications for bank management, investors, and regulators, and proposes recommendations for improving practice and future research.

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter reviews the literature relevant to the impact of finance lease on the performance of Nigerian banks. The review covers the historical background of leasing, the concept of leasing, lease financing by Nigerian banks, the impact of leasing on bank performance, the theoretical framework underpinning the study, and a summary of the literature. The chapter provides the theoretical and empirical foundation for understanding how finance leases affect bank financial metrics and performance.

2.2 Historical Background of Leasing

The concept of leasing dates back to ancient civilizations. In ancient Mesopotamia (circa 2000 BC), farmers leased land from landowners in exchange for a share of the harvest. In ancient Greece and Rome, leases were used for land, buildings, and ships. However, modern leasing as a financing mechanism emerged during the Industrial Revolution in the 19th century, when railroads and industrial equipment were leased to spread the high cost of capital assets (Nevitt and Fabozzi, 2018; Amembal, 2019).

The modern leasing industry began in the United States in the 1950s. The first independent leasing company, United States Leasing Corporation (now U.S. Bancorp Equipment Finance), was founded in 1952. The growth of leasing was driven by several factors: (a) tax incentives (lessors could claim depreciation deductions), (b) the need for businesses to conserve working capital, (c) technological change (equipment became obsolete faster, making leasing attractive), and (d) the development of the capital markets for lease financing (Schallheim, 2018).

In the United Kingdom, leasing grew rapidly in the 1960s and 1970s, with banks entering the leasing market. In Europe, leasing became popular in the 1970s and 1980s. Today, leasing is a multi-trillion-dollar global industry, covering everything from aircraft and ships to computers and medical equipment. In the banking industry, leasing has become an important financing activity, with many banks establishing leasing subsidiaries or departments (Nevitt and Fabozzi, 2018).

In Nigeria, leasing began in the 1960s with simple equipment rental agreements. The modern leasing industry emerged in the 1980s following the introduction of the Structural Adjustment Programme (SAP), which reduced government expenditure and forced businesses to seek alternative financing. The first specialized leasing company in Nigeria, Equipment Leasing Company of Nigeria (ELCN), was established in 1984. The industry grew in the 1990s and 2000s, with banks entering the leasing market. The Central Bank of Nigeria (CBN) issued guidelines for bank participation in leasing, and the National Office for Technology Acquisition and Promotion (NOTAP) issued guidelines for technology leasing (Ogbeifun, 2019; Adebayo and Oyedokun, 2020).

The accounting treatment of leases has evolved significantly. Under the original leasing standard, IAS 17 (Leases), leases were classified as either finance leases (recorded on the balance sheet) or operating leases (off-balance-sheet). This classification was often used by companies to keep lease liabilities off the balance sheet (off-balance-sheet financing). In response to concerns about off-balance-sheet financing, the International Accounting Standards Board (IASB) issued IFRS 16 (Leases), effective from 1 January 2019. IFRS 16 eliminated the distinction between finance and operating leases for lessees, requiring all leases (with limited exceptions) to be recognized on the balance sheet (IFRS Foundation, 2021; IASB, 2018).

2.3 Concept of Leasing

A lease is a contractual agreement where the lessor (owner of the asset) grants the lessee (user of the asset) the right to use an asset for a specified period in exchange for periodic lease payments. Leasing allows businesses to use assets without the large upfront cash outlay required for outright purchase.

Key Parties in a Lease:

• Lessor: The owner of the asset (could be a bank, leasing company, or manufacturer).
• Lessee: The user of the asset (could be a business or individual).

Types of Leases:

Finance Lease (Capital Lease) : A lease that transfers substantially all the risks and rewards incidental to ownership of an asset from the lessor to the lessee. Under a finance lease, the lessee records the leased asset as an asset on its balance sheet and recognizes a corresponding liability for the future lease payments. Characteristics include: (a) the lease term covers most of the asset’s useful life, (b) the present value of lease payments is substantially all of the asset’s fair value, (c) the lessee has the option to purchase the asset at a bargain price (bargain purchase option), or (d) ownership of the asset transfers to the lessee at the end of the lease term (IFRS Foundation, 2021).

Operating Lease: A lease that does not transfer substantially all the risks and rewards of ownership. Under an operating lease, the lessor retains the asset on its balance sheet, and the lessee records only the periodic lease payments as rent expense. Operating leases are typically shorter-term and used for assets that the lessee does not intend to own (Kieso, Weygandt, and Warfield, 2019).

Sale and Leaseback: A transaction where the owner of an asset sells the asset to a lessor and simultaneously leases it back. This allows the seller-lessee to raise cash (from the sale) while retaining the use of the asset. Sale and leaseback is common for real estate and equipment financing (Schallheim, 2018).

Direct Financing Lease: A lease where the lessor (typically a bank or finance company) purchases an asset and leases it to the lessee. The lessor earns interest income over the lease term (Nevitt and Fabozzi, 2018).

Leveraged Lease: A lease involving three parties: a lessee, a lessor, and a lender. The lessor borrows a significant portion of the asset’s purchase price from a lender (non-recourse debt), and the lease payments are used to repay the loan. Leveraged leases are common for high-value assets like aircraft and ships (Amembal, 2019).

Tax Lease: A lease structured to pass tax benefits (depreciation deductions) from the lessor to the lessee. Tax leases are common in jurisdictions with favorable tax treatment for leasing (Schallheim, 2018).

Advantages of Leasing for lessees include: (a) conservation of working capital (no large upfront payment), (b) protection against obsolescence (ability to upgrade equipment), (c) off-balance-sheet financing (under IAS 17, for operating leases), (d) tax benefits (lease payments are tax-deductible), (e) flexibility (shorter commitment than ownership), and (f) access to specialized equipment. Disadvantages include: (a) higher total cost than outright purchase (interest cost), (b) no ownership of the asset at the end of the lease, (c) ongoing payment obligations (if business conditions deteriorate), and (d) potential restrictions in lease agreements (e.g., maintenance obligations) (Nevitt and Fabozzi, 2018).

2.4 Lease Financing by Nigerian Banks

Nigerian banks participate in lease financing both as lessors (providing lease financing to customers) and as lessees (acquiring assets for their own use through leases). The Central Bank of Nigeria (CBN) recognizes leasing as a permissible banking activity, subject to prudential guidelines.

Banks as Lessors (Providing Lease Financing) :

Nigerian banks provide lease financing to customers for various assets, including:

• Equipment leasing: Machinery, generators, construction equipment, industrial equipment.
• Vehicle leasing: Cars, trucks, buses for commercial and personal use.
• IT equipment leasing: Computers, servers, telecommunications equipment.
• Medical equipment leasing: Diagnostic equipment, hospital beds, surgical equipment.
• Agricultural equipment leasing: Tractors, harvesters, irrigation equipment.
• Marine and aviation leasing: Ships, boats, aircraft (typically through specialized subsidiaries).

Lease financing by banks is typically structured as direct financing leases or finance leases. The bank (lessor) purchases the asset requested by the customer and leases it to the customer for a fixed term (typically 3-5 years). The customer makes periodic lease payments (monthly, quarterly). At the end of the lease term, the customer may have the option to purchase the asset at a predetermined residual value (CBN, 2020; Nwankwo and Okeke, 2021).

Benefits for Banks as Lessors:

• Interest income: Lease financing generates interest income over the lease term.
• Asset control: The bank retains ownership of the asset (in a direct financing lease), providing security in case of default.
• Diversification: Lease financing diversifies the bank’s loan portfolio beyond traditional loans.
• Customer relationship: Lease financing can strengthen customer relationships, leading to cross-selling opportunities.
• Tax benefits: The bank can claim depreciation deductions on leased assets (Adebayo and Oyedokun, 2020).

Risks for Banks as Lessors:

• Credit risk: The lessee may default on lease payments.
• Residual value risk: The asset may be worth less than the estimated residual value at the end of the lease.
• Asset risk: The asset may be damaged, destroyed, or become obsolete.
• Interest rate risk: If lease payments are fixed, rising interest rates reduce profitability.
• Regulatory risk: Changes in leasing regulations or tax laws may affect profitability (Okafor and Udeh, 2020).

Banks as Lessees (Acquiring Assets through Leases) :

Nigerian banks also use leases to acquire assets for their own operations, including:

• Land and buildings: Bank branches, head offices, data centers, and other facilities.
• IT equipment: Servers, computers, networking equipment, ATMs.
• Vehicles: Fleet vehicles for cash-in-transit, staff transportation, and executive cars.
• Office equipment: Furniture, photocopiers, printers.
• Security equipment: CCTV cameras, alarm systems, access control systems.

Under IFRS 16, banks must recognize right-of-use assets and lease liabilities for all leases (with limited exceptions). This affects their balance sheets, leverage ratios, and capital adequacy calculations (IFRS Foundation, 2021; Okafor and Udeh, 2021).

The volume of lease financing by Nigerian banks has grown in recent years, driven by: (a) increasing demand for equipment financing from SMEs, (b) the need for banks to diversify their loan portfolios, (c) the adoption of IFRS 16 (which made leasing more transparent), (d) the growth of the manufacturing and construction sectors, and (e) the availability of specialized lease financing subsidiaries. However, lease financing still represents a small percentage of total banking assets compared to traditional loans (Nwankwo and Okeke, 2021).

2.5 The Impact of Leasing on the Performance of Banks

The impact of leasing on bank performance can be analyzed from two perspectives: (a) the impact of lease financing (banks as lessors) on bank profitability and risk, and (b) the impact of lease obligations (banks as lessees) on bank financial metrics and regulatory compliance.

Impact of Lease Financing (Banks as Lessors) on Bank Performance:

Profitability: Lease financing generates interest income for banks. The return on lease financing (yield) is typically higher than traditional loans for similar risk profiles due to the asset collateral (the leased asset provides security). However, the cost of funds (interest paid to depositors) must be considered. The net interest margin on lease financing contributes to overall bank profitability (return on assets, return on equity). Studies have found that banks with active lease financing activities have higher net interest margins than banks without (Rose and Hudgins, 2018; Okafor and Udeh, 2020).

Asset Quality: Lease financing assets are classified as loans and advances on the bank’s balance sheet. Non-performing leases (lessees failing to make payments) affect asset quality and require provisioning. The non-performing lease ratio is a component of the overall non-performing loan (NPL) ratio. Banks must monitor lease portfolios closely and take timely action on delinquent lessees. Lease financing secured by assets (the leased asset provides collateral) may have lower loss-given-default (LGD) than unsecured loans (Schallheim, 2018).

Capital Adequacy: Under the CBN’s prudential guidelines, lease financing exposures are treated similarly to loan exposures for capital adequacy purposes. Risk-weighted assets for lease financing depend on the credit rating of the lessee and the nature of the lease (finance lease vs. operating lease for lessor accounting). Banks must hold regulatory capital (Tier 1 and Tier 2) against lease financing exposures. The capital adequacy ratio (CAR) is affected by the volume of lease financing (CBN, 2020; Okafor and Udeh, 2021).

Impact of Lease Obligations (Banks as Lessees) on Bank Performance:

Balance Sheet Effects: Under IFRS 16, banks must recognize right-of-use assets and lease liabilities for all leases (with limited exceptions). This increases total assets and total liabilities. The increase in total assets reduces return on assets (ROA) unless the assets generate additional profit. The increase in total liabilities increases the debt-to-equity ratio, indicating higher leverage (IFRS Foundation, 2021).

Profitability Effects: Lease expenses are replaced by depreciation of the right-of-use asset and interest expense on the lease liability. The total expense recognized over the lease term is typically similar to the total lease payments under the previous standard. However, the timing of expense recognition changes (front-loading of expenses due to interest). This can affect profit in the early years of the lease (IASB, 2018).

Return on Assets (ROA) : ROA = Net Profit ÷ Total Assets. Under IFRS 16, total assets increase (recognition of right-of-use assets) while net profit may decrease (due to front-loaded interest expense). The combined effect is a reduction in ROA. Studies have found that ROA decreased for banks with significant lease obligations after IFRS 16 adoption (Okafor and Udeh, 2021).

Return on Equity (ROE) : ROE = Net Profit ÷ Shareholders’ Equity. Under IFRS 16, net profit decreases while equity is unchanged (unless lease liabilities are restructured as equity). Therefore, ROE decreases. The magnitude of the decrease depends on the volume of lease obligations relative to equity (Penman, 2018).

Debt-to-Equity Ratio: Debt-to-Equity = Total Liabilities ÷ Shareholders’ Equity. Recognition of lease liabilities increases total liabilities, increasing the debt-to-equity ratio. This may affect the bank’s credit rating, cost of borrowing, and compliance with debt covenants (Brigham and Ehrhardt, 2017).

Capital Adequacy Ratio (CAR) : CAR = (Tier 1 Capital + Tier 2 Capital) ÷ Risk-Weighted Assets. Under IFRS 16, risk-weighted assets may increase (if right-of-use assets are assigned a risk weight). Lease liabilities are not included in regulatory capital but affect risk-weighted assets. The net effect on CAR may be negative, potentially bringing banks closer to regulatory minimums (CBN, 2020; Rose and Hudgins, 2018).

Cost-to-Income Ratio: Cost-to-Income = Operating Expenses ÷ Operating Income. Depreciation of right-of-use assets is included in operating expenses, increasing the cost-to-income ratio. However, the leased asset may generate additional income (if used for revenue-generating activities), partially offsetting the effect (Okafor and Udeh, 2020).

Liquidity Ratios: Lease liabilities are obligations that require cash outflows over time. Banks must ensure sufficient liquidity to meet lease payment obligations. Lease obligations are included in the bank’s cash flow projections and liquidity coverage ratio calculations (Rose and Hudgins, 2018).

Empirical Studies on Leasing and Bank Performance:

Several empirical studies have examined the impact of leasing on bank performance. In developed markets, studies have found that lease financing is positively associated with bank profitability (higher net interest margins) but also with higher credit risk (higher NPL ratios for lease portfolios). In emerging markets, lease financing is associated with increased access to credit for SMEs, but the impact on bank performance is mixed (Nevitt and Fabozzi, 2018; Schallheim, 2018).

In Nigeria, studies have found that IFRS 16 adoption significantly affected bank financial statements. A study by Okafor and Udeh (2021) found that the adoption of IFRS 16 increased total assets by an average of 5-15% for Nigerian banks, increased total liabilities by similar amounts, reduced ROA by 0.5-1.5 percentage points, and increased the debt-to-equity ratio by 2-8%. The impact varied across banks depending on the volume of lease obligations. Banks with significant branch networks (many leased properties) were most affected (Okafor and Udeh, 2021).

Another study by Adebayo and Oyedokun (2020) found that Nigerian banks with active lease financing subsidiaries had higher net interest margins than banks without, but also had higher non-performing loan ratios. The study concluded that lease financing is profitable but requires strong credit risk management.

2.6 Theoretical Framework

The theoretical framework for this study is anchored on several theories that explain the relationship between leasing and bank performance. These theories provide the conceptual foundation for understanding why banks engage in lease financing, how leasing affects bank financial metrics, and what factors influence the impact of leasing on performance.

2.6.1 The Irrelevance Theory of Leasing (Modigliani-Miller Theorem Extension)

The Modigliani-Miller (MM) Theorem (Modigliani and Miller, 1958) states that, in perfect markets, the value of a firm is unaffected by its capital structure (the mix of debt and equity). An extension of the MM Theorem to leasing suggests that, in perfect markets, leasing is equivalent to buying the asset with debt financing; the choice between leasing and buying does not affect firm value. However, in imperfect markets (with taxes, transaction costs, information asymmetry, and agency costs), leasing may create value (Miller and Upton, 1976; Schallheim, 2018).

In the context of Nigerian banks, the MM Theorem extension suggests that leasing may create value due to tax benefits (lessors can claim depreciation), transaction cost advantages, and information asymmetry between banks and lessees. Banks may prefer leasing over lending because the leased asset provides collateral, reducing credit risk. Lessees may prefer leasing because it preserves working capital and may offer lower effective costs (Nevitt and Fabozzi, 2018).

2.6.2 The Debt Displacement Theory

The Debt Displacement Theory (Myers, 1977; Myers and Majluf, 1984) suggests that leasing and debt are substitutes. When a firm uses leasing, it reduces its capacity to issue additional debt because lease obligations are fixed payment obligations similar to debt. In other words, leasing “displaces” debt. For banks, this means that lease obligations reduce borrowing capacity. Under IFRS 16, the recognition of lease liabilities explicitly displaces debt capacity (Okafor and Udeh, 2021).

The Debt Displacement Theory has implications for bank capital adequacy. Lease liabilities increase total liabilities, reducing the capacity for additional debt financing. Banks with significant lease obligations may need to maintain higher capital ratios to absorb potential losses (CBN, 2020).

2.6.3 The Tax Benefit Theory

The Tax Benefit Theory (Miller and Upton, 1976) suggests that leasing is attractive when there are tax asymmetries between lessor and lessee. If the lessor has a higher tax rate than the lessee, the lessor can claim depreciation deductions that are more valuable (reduce taxes more). The lessor can pass some of these tax benefits to the lessee through lower lease payments, making leasing attractive for the lessee. In the banking industry, banks (lessors) typically have higher tax rates than many corporate lessees, making lease financing tax-efficient (Schallheim, 2018).

In Nigeria, banks face a corporate income tax rate of 30% (plus tertiary education tax). Many lessees (SMEs) may have lower effective tax rates or may not pay taxes consistently. Therefore, lease financing by banks can provide tax benefits that are shared between the bank and the lessee (Adebayo and Oyedokun, 2020).

2.6.4 The Agency Cost Theory

The Agency Cost Theory (Jensen and Meckling, 1976) explains conflicts of interest between principals (shareholders) and agents (managers). In the context of leasing, agency costs arise when managers make leasing or buying decisions that benefit themselves rather than shareholders (e.g., choosing leasing to avoid scrutiny of large capital expenditures). Leasing may also reduce agency costs by limiting the ability of managers to waste free cash flow on unprofitable investments (the “free cash flow hypothesis”) (Stulz, 1990).

For Nigerian banks, agency costs may influence the decision to lease assets (e.g., bank branches). Leasing may provide flexibility (ease of relocation) and reduce the risk of overinvestment in fixed assets. However, under IFRS 16, lease liabilities are recognized, reducing the off-balance-sheet benefits of leasing (Okafor and Udeh, 2020).

2.6.5 The Signaling Theory

The Signaling Theory (Spence, 1973; Ross, 1977) suggests that firms use financial decisions to signal private information to the market. The choice between leasing and buying may signal management’s confidence in the firm’s future prospects. A decision to lease (rather than buy) may signal that management expects rapid technological change (avoiding obsolescence) or that the firm has limited access to debt financing (Nevitt and Fabozzi, 2018).

For Nigerian banks, the choice to use lease financing (as lessee) may signal to investors and regulators that the bank is managing its capital efficiently. The choice to offer lease financing (as lessor) may signal that the bank has expertise in specialized financing and strong credit risk management (Adebayo and Oyedokun, 2020).

2.6.6 Synthesis of Theoretical Framework

The theoretical framework for this study integrates these theories to explain the impact of finance lease on the performance of Nigerian banks. The Irrelevance Theory (Modigliani-Miller extension) suggests that leasing affects firm value only in imperfect markets. The Debt Displacement Theory explains the substitution between leasing and debt. The Tax Benefit Theory explains the tax advantages of leasing. The Agency Cost Theory explains managerial incentives in lease decisions. The Signaling Theory explains how leasing decisions convey information to the market. Together, these theories provide a comprehensive foundation for analyzing the impact of finance lease on bank performance metrics such as ROA, ROE, debt-to-equity, CAR, and cost-to-income.

2.7 Summary

This chapter has reviewed the literature on the impact of finance lease on the performance of Nigerian banks. The historical background of leasing shows that leasing has ancient origins but modern leasing emerged in the 1950s. In Nigeria, leasing grew in the 1980s and 1990s, with banks entering the leasing market. The concept of leasing distinguishes between finance leases (recognized on the balance sheet) and operating leases (off-balance-sheet under IAS 17). Under IFRS 16, the distinction is eliminated for lessees.

Lease financing by Nigerian banks includes both banks as lessors (providing lease financing to customers) and banks as lessees (acquiring assets through leases). The impact of leasing on bank performance includes: (a) for banks as lessors – interest income, asset quality (non-performing leases), capital adequacy, and diversification benefits, and (b) for banks as lessees – recognition of right-of-use assets and lease liabilities, affecting ROA, ROE, debt-to-equity, CAR, and cost-to-income. Empirical studies have found that IFRS 16 adoption reduced ROA and increased debt-to-equity for Nigerian banks.

The theoretical framework includes the Irrelevance Theory, Debt Displacement Theory, Tax Benefit Theory, Agency Cost Theory, and Signaling Theory. These theories explain the conditions under which leasing affects firm value and bank performance.

The literature review reveals gaps in empirical research on the impact of finance lease on Nigerian bank performance. Specifically, there is limited research on the differential impact of IFRS 16 across bank tiers, the effect of lease volume on capital adequacy, and the relationship between lease financing (as lessor) and bank profitability. This study aims to fill these gaps.