Foreign exchange risk management: strategies and techniques used by banks in Kenya to manage foreign exchange risk exposure

Abstract

Considering that the banking sector is the backbone of the Kenyan economy, and that it is a critical vehicle that links the Kenyan economy to the rest of the world, which brings with it a myriad of risks particularly so the foreign exchange risk, adoption of appropriate risk management strategies and techniques is therefore an essential ingredient of a successful banking system in Kenya. Many of the standard tools used to hedge currency risk, such as futures, swaps and options contracts, are either not available in emerging markets or, where available, are traded in illiquid and inefficient markets, making the range of products available extremely limited. This has put an extra burden on corporate treasurers to be able to find adequate hedge to their exposures in exotic currencies. Therefore, the purpose of this study was to find out what strategies and techniques are used by banks in Kenya to manage foreign exchange risk. To achieve this, the researcher sought to ascertain the strategies and techniques used by banks in Kenya to manage foreign exchange risk. The research design adopted in the study was a census survey. The population used consisted of 42 commercial banks licensed to operate in Kenya as listed by the Central Bank of Kenya. Primary data collection, through the use of a questionnaire, was used to gather information from the target population outlining issues relevant to the study. Analysis was then done using Microsoft Excel. The analysis sought to generate descriptive statistics and frequencies. Finally the presentation of the results was done by use of frequency tables, graphical presentation and pie-charts. The results of the study showed that the forward contract was the most frequently used instrument. The money market hedge and the currency swap were also frequently used. Parallel loans (Back-to-back loan), foreign currency denominated debt and cross hedging techniques were moderately used. Futures contract, foreign currency option and leading and lagging techniques were occasionally used. Prepayment was the least used technique.