The effect of foreign exchange risk management on financial performance of microfinance institutions in Kenya

Abstract

Foreign exchange risk management is complex and requires a thorough understanding of the MFI’s business needs, its internal and external environment and exposures to the financial markets. Although there is a growing literature linking foreign exchange risk management to company performance there is, equally, a growing diversity of results. The study thus sought to assess the effect of foreign exchange risk management on financial performance of MFIs in Kenya. A descriptive study design was utilized to examine and explore descriptive characteristics of several variables of interest. The target population for this study constituted the 44 MFI’s registered by the Association of Microfinance Institutions of Kenya. The primary data was collected from the MFI’s by use of self-administered questionnaires to; loans officers/credit officers, accountants and treasury/risk managers. Secondary data was on the other hand requested for from individual MFI’s records & publications. Multiple linear regression analysis was used to examine the magnitude of influence of the independent variable on the respective dependent variables. It was found out that a strong positive relationship exists between financial performance in terms of ROA and use of forward contracts and options as foreign exchange risk management techniques. A positive relationship is further observed between ROA and all the other independent variables. It was also noted from the descriptive statistics that: CFOs define the foreign exchange management policies in most MFIs; the CEOs are in charge of the implementation of the foreign exchange risk management policies; and a relatively close frequency is observed in the measurements suggesting the possibility of foreign exchange risks and the degree of alertness towards countering the risks among the institutions The study recommends that MFIs should explore avenues to enhance capacities within them for managing foreign exchange risk. They should explore the route of continued education for those in workplaces through short term training that should be very practical oriented. The study also recommends that firms should look at instituting a sound risk management system and also needs to formulate their hedging strategy that suits their specific firm characteristics and exposures.