FOREIGN EXCHANGE RISK MANAGEMENT: STRATEGIES AND TECHNIQUES USED BY BANKS IN KENYA TO MANAGE FOREIGN EXCHANGE RISK EXPOSURE

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.
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Matching/ Natural hedging was the most utilized strategy. Engaging in spot transactions was also widely used. Diversification whereby banks financed in different currencies and or in different markets was employed by a few banks. Some banks engaged in risk sharing strategy and also invoiced in strong currencies. Avoidance was also employed to some extent. Netting was the least used strategy.
In conclusion, the strategies and techniques used by banks in Kenya to manage foreign exchange risk are matching/ natural hedging, engaging in spot transactions, diversification, risk sharing, invoicing in strong currencies, avoidance netting, money market hedge, parallel loans(back-to-back loan), foreign currency denominated debt and cross hedging, forward contract, futures contract, foreign currency option and leading and lagging and prepayment. The forward contract is the most frequently used instrument.
It can also be concluded from the study that majority of the banks in Kenya hedge all positions immediately. Others hedge selectively while some of the banks create additional exposure beyond that arising from its business activities in order to profit from exchange rate changes, meaning that the currency market in Kenya is not information efficient. Minority of banks use a fixed rule for partial hedging while leaving the remainder exposed. It can also be concluded that some banks do not hedge against foreign exchange rate risk at all.
In light of the above findings, it’s imperative that banks in Kenya pick out best practices from each other and abroad in order to put foreign exchange exposure under control to mitigate the effects of losses due to this risk from resulting in crises in the economy.

 

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