ABSTRACT
The focus of this research was
on foreign exchange risk management and commercial banks performance in
Nigeria. The objective of this research was to determine the effect of foreign
exchange risk management on the profitability of commercial banks in Nigeria,
to determine the effect of foreign exchange risk management on the
shareholders’ fund of commercial banks in Nigeria, identify risks associated
with foreign exchange in the Nigerian banking industry and determine the
foreign exchange risk management techniques mostly used by commercial banks in
Nigeria. A detailed presentation and analysis of data
used use in obtaining the result that explains Foreign
Exchange Risk Management and Commercial Banks Performance in Nigeria and this
consists Statement of accounts of First Bank of Nigeria, UBA Bank, Access Bank,
Diamond Bank and Standard Chartered Bank for the period, 2011-2015. The
data used for this study included; Returns on Equity (ROE), Returns on Asset
(ROA), Prime Lending Rate (PLR), Non-Performing Loans (NPL), Exchange Rate
(EXCH) and Bank Size (BNKSZ) measured by Total Asset. ROE, ROA, PLR, NPL and
BNKSZ were available from 2011 to 2015. Findings of the study show that there
is a negative impact of exchange rate on bank’s profitability as measured by returns
on equity. The result shows that a unit increase in exchange rate which is
devaluation causes bank’s profitability to drop by 1.08%. This result is so
simply because exchange rate devaluation increases the cost of banking
operations and hence imported banks automation and other activities are grossly
managed. Hence the null hypothesis is rejected and alternative is accepted and
we conclude that there is a significant relationship between the effects of
foreign exchange risk management on the profitability of commercial banks in
Nigeria. As part of recommendation, the issues
related to foreign exchange trading should always be taken into account in
efforts to improve banks’ foreign exchange transactions and financial
performance.
Also, the Government should put in place more measures to increase the
country’s exports as this will go a long way in improving the performance of
commercial banks in Nigeria.
TABLE
OF CONTENT
Pages
Title Page i
Certification ii
Dedication iii
Acknowledgement iv
Abstract v
Table of Content vi
CHAPTER
ONE: INTRODUCTION
1.1
Background to the Study 1
1.2
Statement of the Problem 3
1.3 Aims
and Objectives 4
1.4
Research Question 4
1.5 Research Hypotheses 5
1.6
Significance of the study 5
1.7 Scope
of study 6
1.6
Definition of Terms 6
References 7
CHAPTER
TWO: LITERATURE REVIEW
2.0
Preamble 8
2.1
Conceptual Framework 8
2.2 The Concept of Policies for Currency Risk Management 10
2.2.1 The
Concept of Market Risk Management 11
2.2.2
Foreign Exchange Risk Management 12
2.3
Theoretical Framework 13
2.3.1
Foreign Exchange Exposure Theory 13
2.3.2
Interest Rate Parity Theory 14
2.3.3
Arbitrage Pricing Theory
14
2.4.1 Effect of Foreign Exchange Risk
Management and 15
Commercial Banks performance
2.4.1 Risk Management Process 16
2.4.2 The Concept of Risk Exposure Limits 16
2.4.3 Currency Position Limits 18
2.4.4 The Concept of Settlement Risk 19
2.4.5 The Concept of Counterpart Risk 20
2.4.6 The Concept of Revaluation Risk 20
2.4.7 The Concept of Liquidity Risk 21
2.4.7.1 Forward Contract 22
2.4.7.2 Cross-currency Swaps 22
2.4.7.3 Leading and Lagging 22
2.5 Review of Empirical Studies 25
2.5.1 Empirical Study of the origin and
components Currency risk 27
2.5.2
Empirical Study of Operational Risk Management in a Bank Treasury 27
Environment
2 .6 Related Party Financing 28
2.6.1 Management
policies to reduce loan risk 29
2.6.2 Lending Authority 29
2.6.3 Type of Loans and Distribution by
Category 30
2.6.4 Appraisal Process 30
2.6.5 Loan Pricing
30
2.6.6 The needs for liquidity 31
2.6.7 A Model of Total Growth of a Bank’s
Assets and Capital 33
References 35
CHAPTER
THREE: RESEARCH METHODOLOGY
3.0 Preamble 38
3.1 Research Design 38
3.2
Population of the Study
39
3.3
Sample size and Sample Technique
39
3.4
Model Specification
39
3.5
Sources and Measurement of Data
41
3.6
Criteria for Decision Making under the Regression Analyses 41
References 44
CHAPTER
FOUR: PRESENTATION AND ANALYSIS OF DATA
4.0
Presentation and Analysis of Data 45
4.1
Descriptive Statistics
45
4.1.1
Econometric Analyses 45
4.1.2.1 Unit
Root Test
45
4.1.2.2
Co-integration Test 47
4.1.2.3
Testing Hypothesis One 48
4.1.2.4
Discussion of Results 48
4.1.2.5
Testing Hypothesis Two
49
4.1.2.6 Discussion of Results
50
CHAPTER
FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.0.
Introduction 51
5.1.
Summary of Finding 51
5.2
Conclusion 53
5.3
Recommendations
54
5.4
Limitation of Study
54
5.5
Suggestions for further studies 55
Bibliography
56
Appendix 60
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
Foreign Exchange rate plays an increasingly significant role in any
economy as it directly affects domestic price level, profitability of traded
goods and services, allocation of resources and investment decision. The
foreign exchange rate in Nigeria today has gone from bad to worse rising from N197 to $1 about a year ago to N
318- $1 dollar (5/08/2016) according to exchangerate.org.uk and this is
an increase of 167% just within the space of one year. The problems of foreign
exchange risk management on performance of banks in Nigeria are independent
from banks core business and therefore, it is usually handled by the banks
corporate treasuries. Lee (2010) added that most multinational banks have also
risk committees to oversee the treasury’s strategy in managing exchange rate
issues and it is important that firms create risk management issues and
techniques.
The liberalisation of the exchange rate regime in 1986 has led to
introduction of various techniques with the view of finding the most
appropriate method for achieving acceptable exchange rate. Foreign exchange
rate risk management is an integral part of every bank decision about foreign
currency exposure (Allayannis, Ihrig, and Weston, 2001). Evan et al (1985)
defined foreign exchange risk management as a program concerned with the
identification and quantification of counterstrategies to deal with foreign
exchange rate risk and to ensure profitability of most banks. Kirt (2004)
further added that foreign exchange risk is a financial risk which is used to
manage value creation and loss prevention in a firm by internal and external
financial tools.
Piet and Raman (2012) noted that spot rate changes are offset by
changes in inflation though small firms may depend on unstable currency rates
for profits. Taggert and McDermott (2000) asserted that forex related firms are
subject to foreign exchange risk on the payables and receipts in foreign
currencies. Papaioannou (2001) referred to foreign exchange risk as the risk
related with the unexpected changes in exchange rates and foreign exchange
exposure as the extent to which unexpected changes in exchange rates affect the
value of a firm’s assets or liabilities.
According to Featherson, Littlefield and Mwangi (2006), foreign exchange
risk arises when fluctuation in the relative values of currencies affects the
competitive position or viability of an organization and this exposes banks to
foreign exchange risk if the results of their projects depend on future
exchange rates and if exchange rate changes cannot be fully anticipated.
El-Masry (2006) further added that this exposes banks to, Transaction exposure,
Economic expouijmsure and Translation exposure.
Some
of the major types of foreign exchange rates include Fixed Exchange Rate System
(or Pegged Exchange Rate System); Flexible Exchange Rate System (or Floating
Exchange Rate System). Managed Floating Rate System and managed exchange rate (Salifu et al, 2007). (Nwankwo, 1980) noted that Nigeria has moved
to various types of floating regimes of exchange rate from the fixed/pegged
regimes between 1960s and the mid-1980s Since the adoption of the Structural
Adjustment Programme (SAP) in 1986. Floating exchange rate has been shown to be
preferable to the fixed arrangement because of the responsiveness of the rates to
the foreign exchange market (Nwankwo, 1980).
Foreign exchange risk
management strategies entail eliminating or reducing this risk, and require
understanding of both the ways that the exchange rate risk could affect the
operations of economic agents and techniques to deal with the consequent risk
implications (Barton, Shenkir, and Walker, 2002).
According to Papaioannou (2001), selecting
the appropriate risk management strategy is often a daunting task due to the
complexities involved in measuring accurately current risk exposure and
deciding on the appropriate degree of risk exposure that ought to be covered.
Papaioannou (2001) also added that the need for foreign risk management started
to arise after the break down of the Bretton Woods system and the end of the
U.S. dollar peg to gold in 1973. Exchange rate volatility creates a risky
business environment in which there are uncertainties about future profits and
payments. World Bank & MTTI (2006) report stated that these are especially
exacerbated in countries where financial instruments for hedging against
foreign exchange risk are not developed, which is the case in many developing
countries including Nigeria. Therefore, the central focus of this research is
to examine foreign exchange risk management and commercial Banks performance in
Nigeria.
1.2 Statement
of the Problem
Foreign Exchange risk comes about as a disparity between the assets
held by banks and the loans that fund its balance sheet. An unexpected
depreciation of the local currency against the USD can dramatically increase
the cost of servicing debt relative to revenues. It can also negatively affect
the creditworthiness of the bank (hence the ability to raise new funds) and
even generate a negative net income, with serious consequences for the long-term
financial stability of the bank (Moles, 2002).
According to Moles (2002), Banks and
Insurance companies are particularly vulnerable to foreign exchange
rate risk, since they operate in developing countries where the risk of
currency depreciation is high.
The banking industry in Nigeria is characterized by
numerous teething problems and these resulted from their types of customers and
the seemingly liberal and/or informal system of operations. The rapid increase
in private sector, international investment in microfinance, plus a dose of
common sense, makes foreign exchange risk management an important topic for
Insurance especially as it regards performance. Also, today in Nigeria, the
foreign exchange rate to the Nigeria currency (Naira) is disheartening and this
has caused lots of businesses in the country to liquidate or go bankrupt. Also,
the Nigeria banks are blamed by most organisations and business men for being
responsible for the high exchange rate of foreign currency to the Naira and this
issue is beginning to grossly affect banks as most banks are beginning to
secretly and silently lay off workers.
Therefore this research intends to examine foreign
exchange risk management and commercial Banks performance in Nigeria.
1.3 Aim and Objectives
of the Study
The aim of this study is to determine the
effects of foreign exchange risk management on the performance of commercial banks
in Nigeria. The specific objectives are:
i.
To determine the effect of
foreign exchange risk management on the profitability of commercial banks in
Nigeria
ii.
To determine the effect of
foreign exchange risk management on the shareholders’ fund of commercial banks
in Nigeria.
iii.
To determine the foreign exchange
risk management techniques mostly used by commercial banks in Nigeria to manage
risk exposures
iv.
To identify risks associated
with foreign exchange in the Nigerian banking industry.
1.4 Research Questions
i.
What are the effects of
foreign exchange risk management on the profitability of commercial banks in
Nigeria?
ii.
What are the effects of
foreign exchange risk management on the shareholders’ fund of commercial banks
in Nigeria?
iii.
What are the risk management
techniques mostly used by commercial banks in Nigeria to manage foreign risk
exposures?
iv.
What are the risks associated
with foreign exchange in the Nigerian banking industry?
1.5 Research Hypotheses
Hypothesis One
H0: There is no significant relationship between the effects of
foreign exchange risk management on the profitability of commercial banks in
Nigeria.
H1:
There is significant relationship between the effects of foreign
exchange risk management on the profitability of commercial banks in Nigeria.
Hypothesis Two
H0:
There is no significant relationship between the effects of
foreign exchange risk management on the shareholders’ fund of commercial banks
in Nigeria.
H1:
There is significant relationship between the effects of foreign
exchange risk management on the shareholders’ fund of commercial banks in
Nigeria.
1.6 Significance of the
Study
This study will provide a basis for closer
scrutiny of the formulations and applications of the different relevant aspects
of foreign exchange risk management in existence and in use especially in the
Nigeria banking industry. The study will also provide answers regarding
contemporary applications of risk management, its relative importance with
respect to corporate goals and its degree of applicability in specific business
concerns and also, its effects on banks in Nigeria.
This study will be of more relevance to
top level managers with whom foreign risk management programmes are being
entrusted with and also to the banking industry in general. The government
would benefit from this study as they would look at areas in which they
can improve by further implementing
policies that can assist the banks in minimizing foreign exchange risk so as to
safeguard the investment of bank customers and bank asset. Researchers would
benefit from this study as they can delve into the work and seek out ways to
further improve on it, seeing as the need to continually improve on knowledge
is unquenchable.
1.7 Scope of the Study
The basic premise of the study is to
evaluate foreign exchange risk management and commercial banks performance in Nigeria.
Selected Banks in Nigeria will serve as the organization of study for this
research work. Effort will be made to identify foreign exchange risks
associated with the activities of selected commercial banks in Nigeria as well
as its effect on the performance of the selected banks.
1.8
Definition of Terms
Banks: A business that keeps money for individual people or companies,
exchanges currencies, makes loans, and offers other financial services.
Compliance: The state or act of conforming with or agreeing to do something
Foreign exchange risk: is a financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the company.
Transaction risk: The risk of
an exchange rate
changing between the transaction date and the subsequent settlement date, i.e.
it is the gain or loss arising on conversion.
Economic risk: A change in
the present value
of the future after tax cash flows due to changes in exchange rates.
Uncertainty: The quality or state of being uncertain, that is, something that
nobody can predict. Uncertainty is a potential, unpredictable, immeasurable and
uncontrollable outcome
Risk: The intentional interaction with uncertainty. Risk is a consequence of action taken in spite of uncertainty
Risk impact: The impacts (financial, reputational, regulatory, etc.) that will
happen should the risk event occur.
Risk event: An actual instance of a risk that happened in the past.
Risk cause: The preceding activity that triggers a risk event (e.g. fire was
caused by faulty electrical equipment sparking).
Risk
Management: The procession or
technique of determining, minimizing, and preventing accidental loss in a
business
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