EFFECT OF EXCHANGE RATE FLUCTUATION ON FINANCIAL PERFORMANCE OF COMMERCIAL BANKS IN NIGERIA

1.1 Introduction

Exchange rate is the rate at which a currency is exchanged for another currency. It is referred to as the ratio at which a unit of currency of one country is expressed in terms of another currency. The rate is normally determined in the foreign exchange market. The foreign exchange market is a market where currencies of different countries are bought and sold. As noted by Jhingan (2004), the national currencies of all countries are the stock-in-trade of the foreign exchange market, and as such, it is the largest market to be found around the world which functions in every country. Exchange rate is the value of the one unit of foreign currency against local currency and Exchange rate serves as the basic link between the local and the overseas market for various goods, services and financial assets (Reid and Joshua, 2004).

As a prelude to other parts of this study, this chapter will discuss the background upon which this study was initiated, the statement of problems that led to this study, the Aim and Objectives of the study. Others are Significance of the study, Scope of work, Research hypothesis and questions, Limitations of the Study and Definition of technical terms.

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1.2 Background of Study

Exchange rate fluctuations influence a country’s prices through import prices of consumption and intermediate goods (Watkins, 2014). Currency fluctuations enter directly into the import price, producer price and Consumer Price Index (CPI). 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 (Gatobu, 2013).

Exchange rate of a country plays a key role in international economic transactions because no nation can be self-sufficient due to varying factor endowments. International trading helps in achieving economic balance as countries’ easily fill their need-gap. The globalization of economic activities also encouraged the growth of companies beyond their home country and the operation of diverse companies as a single organization which cuts across countries. The implication is that exchange rate is the backbone of their business. This goes to a large extent in determining the extent of return on investments in the midst of variations in exchange rate. Nigeria as a whole has been over-burdened with the challenge of declined Naira value with effect that more naira are needed to secure a unit of other currencies.

This study considers exchange rate to mean the rate at which a unit of foreign currencies are exchanged for Nigerian Naira. Omagwa (2005) posit that exchange rates like any other commodity are explained by the law of demand and supply. Supply of currency is explained by changes in fiscal policies whereas currency demand is influenced by a wide range of factors such as inflation rates and interest rates. Murthy and Sree (2003) argued that exchange rate enables comparison of prices of commodities quoted in diverse currencies. Thomas (2006) found that since the early 1970s, foreign rate exchange system had been a floating one in most countries. The findings were that such nations permitted exchange rates to change in the market place from day to day as per market forces. Before this eventuality central banks of nations intervened in determinations of the exchange rate. This meant that international transactions were never subjected to exchange rate fluctuations risk and as such international transactions were less dynamic. He further stated that since the collapse of this exchange rate system it is markets forces that determine the exchange rate of a nation’s currency. Thus such rates keep on fluctuating as per market forces and therefore exposing international transactions to exchange fluctuation risks.

Therefore, in Nigeria where the research was carried out, the activities that was conducted is to examine the Effect of Exchange Rate Fluctuation on Financial Performance of Commercial Banks.

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1.3 Statement of Problems

Investigation revealed that during the time of depreciating local currency, the export earnings were higher even with low export quantities while export earnings reduced when the currency was appreciating. Fluctuations in exchange rate may be a source of risk to an organization. Huge losses in foreign exchanges may result to organizations failures in addition to instigating enormous burdens on profitability of an organization (Kinyuma, 2013).

Exposure to exchange rates risk due its fluctuations can be discerned basically from an organization’s accounting data, Exchange rate variations in Nigeria are characterized with periods of Naira depreciation, which has negatively affected the Nigeria economy (Jamal and Khalil, 2011).

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1.4 Aim and Objectives of Study

The aim of the study is to examine the effect of exchange rate fluctuation on financial performance of commercial banks in Nigeria. In achieving this aim, the following specific objectives were laid out as follows:

1. To investigate the effects of exchange rate fluctuations on financial performance of financial institutions.
2. To investigate the impacts of exchange rate fluctuations on financial performance of commercial banks in Nigeria.
3. To determine the extent of impact of another variable Interest Rate Spread on the Return on Assets.
4. To investigate the interrelationship among the variables of Return on Assets, Exchange Rate Fluctuation, Interest Rate Spread and Inflation.

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1.5 Research Questions

The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:

• Does exchange rate fluctuations impacts financial performance of commercial banks in Nigeria?
• Is there any interrelationship among the variables of Return on Assets, Exchange Rate Fluctuation, Interest Rate Spread and Inflation?
• What is the extent of impact of another variable Interest Rate Spread on the Return on Assets?
• What are the effects of exchange rate fluctuations on financial performance of financial institutions?

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1.6 Research Hypothesis

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.

Hypothesis One

• H0: Exchange rate fluctuations does not impact financial performance of commercial banks in Nigeria
• H1: Exchange rate fluctuations impacts financial performance of commercial banks in Nigeria

Hypothesis Two

• H0: There are no significant effects of exchange rate fluctuations on financial performance of financial institutions
• H1: There are significant effects of exchange rate fluctuations on financial performance of financial institutions

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1.7 Significance of Study

To the managers of commercial banks in Nigeria, the findings of this study would provide information to guide their management decisions following the changes in the exchange rate in Nigeria for a strong banking industry. For the Government of Nigeria, the findings of this study would inform the formulation of policies and regulations for a strong and resilient banking industry. The findings of this study would inform the fragile foreign currency reserves making it difficult for the banking industry to transact freely.

The study will provide information on impacts of exchange rate fluctuations on financial performance that will benefit academicians and researchers who intend to carry out further research on exchange rate fluctuations and financial performance.

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1.8 Scope of Study

The scope of the research is focused on the effect of exchange rate fluctuation on financial performance of commercial banks in Nigeria.

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1.9 Limitations of the Study

During the course of this study, many things militated against its completion, some of which are:

1. Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
2. Research material: availability of research material is a major setback to the scope of the study.
3. Frequent power failure: This made the researcher append more money on fuel to ensure sustainable power.
4. Financial Constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

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1.10 Definition of Terms

Exchange rate: Exchange rate is the rate at which a currency is exchanged for another currency.