Effects of Exchange Rate Fluctuations on Financial Performance of Commercial Banks in Kenya

Abstract

Financial performance refers to the ability to leverage operational and investment decisions and strategies to achieve a business’ financial stability. It is the measure of a bank’s achievement of its financial goals guided by its financial objectives and benchmarks. Exchange rate fluctuations affect domestic prices through three channels; first is through prices of imported consumption goods, exchange rate fluctuation affects domestic prices directly, second is through prices of imported intermediate goods, exchange rate fluctuation affects production cost of domestically produced goods and third is through prices of domestic goods priced in foreign currency. Foreign exchange rate fluctuations could be an important source of risk for banking institutions. In the worst case, large foreign exchange losses could lead to bank failures besides causing huge burdens on banks’ profitability. The research objective was to determine the effects of exchange rate fluctuations on financial performance of commercial banks in Kenya. The study adopted a descriptive research design. The design was more appropriate because the study sought to build a profile on the effects of exchange rate fluctuations on financial performance of commercial banks in Kenya. The target population comprised all 43 commercial banks operating in Kenya as at December 2014. For this study, all the 43 banks were included because the target population was small and the data was easily accessible from the Central Bank of Kenya. This study used secondary. Secondary data was collected from the banks’ consolidated financial statements as well as Central Bank of Kenya offices. The study used Statistical Package for Social Sciences Version 21.0 to aid in data analysis. The study found that there was a positive relationship between foreign exchange rate fluctuations and the financial performance of banks as measured by the returns on assets ratio. The research findings further revealed that the strength of association between the fluctuations and the returns was a weak one. Results from corelation analysis revealed that a fluctuation in the value of the domestic currency led to an effect on the financial performance of the banks. The study revealed that exchange rate movement also affects the stock market performance greatly especially through its spiral effects. The study concluded that there is a weak relationship between foreign exchange rate fluctuations and the performance of commercial banks in Kenya in the study period. Additionally, the Kenyan shilling exchange rates against the United States Dollar was observed to be really high during the study period. The study recommended relevant authorities for instance. The Central Bank of Kenya should adequately put measures to safeguard the value of the domestic currency. This would ensure that the value on the same does not fluctuate much day in day out.