- EVALUATION OF CONTRIBUTION OF COMMERCIAL BANK TO THE ECONOMIC DEVELOPMENT OF NIGEIRA (A CASE STUDY OF FIRST BANK OF NIGERIA PLC)
- AN EVALUATION OF MANAGEMENT ACCOUNTING TECHNIQUES ON ORGANIZATION DECISION MAKING PROCESS (A CASE STUDY OF CADBURY NIGERIA PLC, IKEJA, LAGOS)
- THE IMPACT OF PERFORMANCE EVALUATION THROUGH THE ANALYSIS OF FINANCIAL STATEMENT ON INVESTMENT DECISIONS (A CASE STUDY OF LOGMAN NIGERIA PLC.)
- ASSESSMENT OF CONTRIBUTION OF COMMERCIAL BANK TO THE ECONOMIC DEVELOPMENT OF NIGEIRA (A CASE STUDY OF FIRST BANK OF NIGERIA PLC)
- COMPENSATION MANAGEMENT AND ORGANIZATIONAL PERFORMANCE (A STUDY OF PZ CUSSIONS NIGERIA PLC)
- THE EFFECT OF FORWARD INTEGRATION ON PERFORMANCE OF MANUFACTURING INDUSTRY (A STUDY OF CADBURY NIGERIA PLC)
- EFFECT OF MANAGEMENT BY OBJECTIVES ON ORGANIZATION PERFORMANCE (A CASE STUDY OF VITAMALT PLC)
- EFFECTS OF PERFORMANCE EVALUATION THROUGH THE ANALYSIS OF FINANCIAL STATEMENT ON INVESTMENT DECISIONS (A CASE STUDY OF LOGMAN NIGERIA PLC.)
- EFFECTS OF LABOUR TURNOVER ON ORGANIZATIONAL PERFORMANCE (A COMPARATIVE STUDY OF UNILEVER AND PZ NIGERIA PLS)
- IMPACT OF COMMERCIAL BANKS IN AGRICULTURAL FINANCING IN NIGERIA (A Case Study of First Bank Nigeria Plc.)
FOREIGN EXCHANGE RISK MANAGEMENT AND COMMERCIAL BANKS PERFORMANCE IN NIGERIA
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
Title Page i
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
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
18.104.22.168 Forward Contract 22
22.214.171.124 Cross-currency Swaps 22
126.96.36.199 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
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
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
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
188.8.131.52 Unit Root Test 45
184.108.40.206 Co-integration Test 47
220.127.116.11 Testing Hypothesis One 48
18.104.22.168 Discussion of Results 48
22.214.171.124 Testing Hypothesis Two 49
126.96.36.199 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
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
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.
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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