FOREIGN EXCHANGE RISK MANAGEMENT IN NIGERIAN ECONOMY AND ITS IMPACT ON PROFIT OF BANKS

1.0 Introduction

1.1 Background of the study

Financial Risk management is a relevant development that arises with deregulation of Nigerian economy through the introduction of Structural Adjustment Program (SAP) in 1986. The research was born out of an inquisitive mind and the desire to gain knowledge about the practice of financial risk management in Nigeria especially in the area of foreign exchange. It should be recalled that Nigerian economy moved away from fixed exchange regime in September 1986. The country returned back to fixed exchange regime in 1994 and guided deregulation in 1995. Cliff (2003) notes that financial risk (which foreign exchange risk is a sub − set) is the chance or probability that some unfavouable event will occur and which will adversely affect the financial foreign exchange risk are financial position or cash flow stream of an organizations other examples of financial risk apart from foreign exchange risk are ownership, liquidity, credit, exchange rate, interest rate etc. The topic foreign exchange risk management is relevant because humans are prone to making mistakes for business concern; all facts of its existence are fraught with risk exposure. The business environment in which companies operates is becoming increasingly complex and uncertain due to the globalization of business and rapid introduction of new technologies. Most business decision are taken with complete knowledge about how the future will evolve with this mind, business managements in twenty first century will emphasize financial risk management.

The successful ones will be assessed on the basis of its ability and capability to anticipate, plan and controls risks. The subject will continue to be relevant in discourse because terms trading and investment are modern terms understood by the world. As long as there is flexible and market determined exchange rate, exchange rate risk will exist and become inevitable. Egwuonwu (1995) stated that foreign exchange risk management is a new phenomenon in the study of risk exposure. This is because little was known about the subject and its practice and also foreign exchange management itself has been given little cognizant in the past and as a result, it was not considered as a possible tool for long term development in the nation’s economy. The breakdown in the fixed foreign exchange rate to a market determines exchange rate was the fundamental factor responsible for the demand for foreign exchange risk management. Also, development in the fields of communication information technology, emergence of global investment called derivative securities (currency futures) options and currency sways) are other factors which contributed to the emergence of the subject. Nigerian business organization are involves in international trade at both export and import level: demand for exchange of currencies and the presence of exchange fluctuation is ever present under the arrangement hence exchange risk becomes a pre − requisities.

The major objective of risk management is to maximize returns and to minimize risk. It is therefore in this light and in an effort to improve the effectiveness of the foreign exchange risk management in Nigeria that this work was undertaken. It could therefore be said that the inherent problems as experienced by the banking industry today can be linked to the partial or total neglect of the cannons of lending by the officers of the bank, attitude towards risk.Foreign exchange is regarded as a vital instrument in banking industry especially as it affects the commercial banking system and hence attention should be focused on this area of endeavor.

1.2 Statement Of The Problem

From what has been said earlier, business organization and firms operate in an environment that is characterized by numerous variables. These variables are dynamic in nature. Two calls for corporate planning and management of foreign exchange risk in an organization in order to cope with the challenges facing foreign exchange risk management. It is widely acknowledge today that the rate, magnitude and complexity involves in the management of risk has not been able to achieve their desired goal. Over the years, the transaction involving the use of foreign exchange has increase so also the increase in the risk involve in foreign exchange transaction. The problem is how to effectively manage these foreign exchange risks.

Hence, some of these questions one is tempted to ask include.

1. What is/are the problems with the management of foreign exchange risk in the Nigerian economy?
2. What measures/steps could be taken to substantially improve foreign exchange risk management in Nigeria?
3. What is/are the cause (s) of this/these problem
4. What role has banks played in improving foreign exchange risk management
5. What are the impacts or strategy for managing foreign exchange risk

1.3 Objective Of The Study

The study will attempt to ask questions and provide answers to the following.

1. To know if there is any significant relationship between foreign exchange risk and profitability.
2. To determine the effectiveness of the techniques and tools being used.
3. To assess the understanding and the depth of knowledge of the practitioners
4. To determine to what extent applicability of the practice of foreign exchange risk management is practiced in the Nigerian economy
5. To determine the constraints why the concerned parties are not applying the techniques
6. Recommend possible modern techniques and how they can be employed in Nigerians economy.

1.4 Research Hypotheses

For the successful completion of the study, the following research hypotheses were formulated by the researcher;

1. H0: there is no relationship between foreign exchange risk and profitability.
   H1: there is relationship between foreign exchange risk and profitability
2. H02: there are no possible modern techniques and how they can be employed in Nigerians economy
   H2: there is possible modern techniques and how they can be employed in Nigerians economy

1.5 Significance Of The Study

The findings of this study will throw more light on the role of foreign exchange risk and why it is good for every organization.

1. To recommend more sophisticated method of managing and controlling foreign exchange risk that would guarantee optimum level of profitability.
2. It will enable the public to know the influence of foreign exchange risk
3. To export the constraints facing foreign exchange risk
4. This work would also serve as a base to subsequent researchers who tend to understand the same topic or work.
5. This topic will be useful to individuals and banks

1.6 Scope And Limitation Of The Study

This research work emphasizes on the practice of foreign exchange risk management in Nigeria economy from bankers and its impacts. Perspective: it is arranged to find out how losses on fluctuation in exchange rate are mitigated, controlled, transferred or minimized by the practitioners. Extensive investigation is conducted on the techniques or tools used and preference (if any) and why such. This work is restricted to the bank under study. And no attempt was made to compare findings with what is obtained in other banks within the same sector. Information was obtained from head office of banks treasury, foreign exchange/ international departments and selected investing company.The researcher encounters some constrain which limited the scope of the study;

a) Availability Of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.

c) Organizational privacy:

Limited Access to the selected auditing firm makes it difficult to get all the necessary and required information concerning the activities

1.7 Definition Of Terms

1. Currency Option:

Currency option is an instrument that gives its buyers the right but not the obligation to buy (all options) or sell (put options) a certain quantity of a specified foreign exchange at a specified rate of exchange (the exercise price) within a certain limited time or at the end of that time (C.R.A Olowe 1997)

2. Currency Future:

These are form of forward contracts, which gives a fixed rate for security price or interest rate or exchange rate at future date.

3. Hedging:

Hedging occurs when an enterprise deliberately invest in an asset or grant loan to depreciate the rate of exchange. Hedging attempts to immunize an investment from currency movements up and down.

4. Currency Swap:

A swap is an instrument that combines a spot purchase (or sale) of foreign currency against a future sale (or purchase) of the same currency in effect, a soap facilitates a temporary exchange currencies.

5. Arbitrage:

This is a process of buying the money of one country in the foreign exchange market and selling it in another at a higher price

6. Spot Transaction:

This is an agreement to deliver some amount of one currency in two business days.

7. Pegged Exchanged Rate:

The official determined exchanged rate under fixed exchange rate

8. Rate of Exchange:

The basis upon which money of one country will be exchange for that of another.

9. Currency Conversion:

It is the process of expressing or stating transaction or operation in foreign currency of one country to that of another using the rate ruling on the transaction date or an agree rate.

10. Currency Translation:

It is the process of restating accounting balance of foreign currencies of one country using appropriate rate methods

1.8 Organization Of The Study

This research work is organized in five chapters, for easy understanding, as follows

• Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
• Chapter two highlights theoretical framework on which the study is based, thus the review of related literature.
• Chapter three deals on the research design and methodology adopted in the study.
• Chapter four concentrate on the data collection and analysis and presentation of finding.
• Chapter five gives summary, conclusion, and recommendations made of the study