Foreign Exchange Risk Management Practices by Foreign Owned Commercial Banks in Kenya

Abstract

This research endeavoured to achieve three objectives: to ascertain the foreign exchange risk management practices of foreign owned commercial banks in Kenya, to determine the extent of foreign exchange risk management by the banks and to rank the ascertained practices in order of importance. Empirical evidence was extensively used to link the findings of the study with prescriptions of academic literature. The study focused . on the head offices of the twelve foreign owned banks in Kenya out of which nine responded. The research was an exploratory study carried out as a census survey. Qualitative primary data was used for the study. Self-administered questionnaires were delivered to the treasury departments of the banks using 'drop and pick later' technique. Descriptive statistics were used to analyze the data. Various inferences were drawn from the findings; the responding banks employed both conventional and bank-specific foreign exchange risk management practices. Most banks considered credit/default risk to be the most critical of all financial risks though empirical evidence shows that foreign exchange risk is the most critical risk for most firms. A strong majority of the banks did not find the Kenyan currency market to be information efficient: speculation.~Rd (orec~~ting techniqu~ were extensively used by most of them. The banks' views on market fundamentals and what constitutes foreign exchange risk management best practices had a significant bearing on hedging practices adopted. Regular and systematic appraisal of exchange risk management policies was a common practice amongst most banks. For most banks, foreign exchange risk management systems were governed by guidelines set at the head office (highly centralized foreign exchange risk management systems). iii The findings from most banks were similar to empirical evidence but considerably inconsistent with recommendations of Ilterature. Most banks, regardless of their size, extensively utilized most of the conventional hedging instruments. Micro hedge approach, accounting, translation and economic exposure measurement strategies, natural hedging, risk sharing and diversification were some of the most utilized strategies. Transaction exposure was rated as the most critical to most banks when compared to translation and economic exposures. Some hedging practices were considered by most banks to be the more important than others. These include use of forward contracts and foreign currency options as hedging instruments, use of matching/natural hedging strategy and preference of selective hedging strategy instead of hedging all positions immediately. The extent of foreign exchange risk management by the banks was also gauged: it emerged that most banks practiced foreign exchange risk management to some extent.