The Effect of Foreign Exchange Risk Management on the Financial Performance of Commercial Banks in Kenya

Abstract

Foreign exchange risk management is complex and requires a thorough understanding of the banks business needs, its internal and external environment and exposures to the financial markets. Challenges abound as banking institutions commit themselves to improving risk management practices. The banking industry in Kenya is characterized by numerous teething problems. These emanate from their calibre of target customers and the seemingly liberal and/or informal system of operations. 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. The objective of the study was to establish the effect of foreign exchange risk management on the financial performance of commercial banks in Kenya. The research used a descriptive research design. The target population comprised of the forty three (43) commercial banks in Kenya. The study used census approach to pick all the 43 commercial banks in Kenya since the population is not large. The study made use of secondary data. The multiple linear regression analysis was applied to examine the extent of influence of the independent variable on the dependent variables. The regression analysis established that ROA = 1.627 + 13.491*Options + 3.113*Forward Contracts + 4.820*Cross Currency Swaps + 0.720*Leading and Lagging - 0.071*Price Adjustments + 0.044*Netting .The study further found that there is a strong relationship between dependent and independent variables given an R2 values of 0.856 and adjusted to 0.801. This shows that the independent variables (Options, Forward Contracts, Cross Currency Swaps, Leading and Lagging, Price Adjustments, Netting) accounts for 80.1% of the variations in profitability as measured by ROA.