FOREIGN EXCHANGE RISK MANAGEMENT IN NIGERIAN ECONOMY AND ITS IMPACT ON PROFIT OF BANKS (A CASE STUDY OF UNITED BANK OF AFRICA)

CHAPTER ONE

INTRODUCTION

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 nations 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.

Statement of Research Problems

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

 Objectives 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.

Statement of Hypothesis

Research hypothesis is a testable statement regarding the relationship between two or more variables that comes from research problems. Aigbokhearvbolo and Ofanson (2004) in fact, research problems cannot be properly address unless it is reduced to hypothesis. Hypothesis is a reasonable guess or statement which is to be tested. (Emele and Emele, 1995).

Hypothesis are stated in Null and alternative form.

The null is the hypothesis one need to reject it states that the variables are mot related. The alternative is the compliments of the null hypothesis, once the null is rejected with the help of both statistical and quantitative analysis the alternative will be accepted and vice verse. Using the topic under study one can now establish the statement of research problem in hypothesis form.

Ho: the banks do not bother themselves with foreign exchange risk while transacting in foreign exchange currencies.

Hi: the banks do bother themselves with foreign exchange risk while transacting in foreign exchange currencies.

H0: Banks do not evaluate the effect of foreign exchange exposure exposures using modern techniques before transactions.

Hi: Banks evaluates the effect of foreign exchange exposure exposures using modern techniques before transactions.

H0: the banks have no administrative policies and control measures in place to reduce foreign exchange risk.

Hi: the banks have administrative policies and control measures in place to reduce foreign exchange risk.

Scope 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.

Significant 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

Limitation of the Study

As previously mentioned earlier foreign exchange risk management practice is not yet at it’s fullest in Nigeria. Few works are in existence on the subject in Nigeria seminars papers, work shop conference proceeding and few text are available.

Also, in the process of gathering the material needed for the project work and data that are relevant for the project the following constraints were witnessed; constraints to data availability, time duration posed a limitation, and the cost to get data and materials was experienced.

Historical Background of United Bank of African (U.B.A)

Since the historical emergence from the merger of former Standard Trust Bank and U.B.A Plc, the U.B.A group was positioned itself to be Nigeria dominant bank and a leading player in African continent. In 2000, Europe’s frontline finance and economy magazine, Euro money named UBA The Best Domestic Bank in Nigeria, in recognition of the banks exponential growth for the past couple of years and the comparatively higher inflow of investment from global finance player and in 2007 pan African Newsmagazine awarded UBA the Emerging Global Bank which has most positively influenced the African continent.

UBA has consistently positioned itself as the bank to beat in Nigeria financially strong banking industry. It has grown total assets by over 345.01 percent in the last five years, up from NGN 198.68 billion ($ 1.656 billion) in 2002 to NGN 884.14 billion central bank of Nigeria, 2007 Bulletin. ( $ 7.368 billion) in 2006 more recently, at the end of 2008 financial year, it recorded gross earnings of NGN 169.6 billion, profit before tax and exceptional items of NGN 56.8 billion and total assets of NGN 2.2 billion (central bank of Nigeria 2008 bulletin)

UBA has the largest distribution network in Nigeria with over 6.5 million customers in personal, commercial and corporate market segments, it has over 14,000 staff globally who are also referred to as a “lions and lioness”

Regionally, the group has a presence in 18 African countries and in all major financial centres. The bank currently operate in Nigeria, Ghana, Ivory coast, Cameroon, Sierra Leone, Liberia, Uganda, Benin, Burkina Faso and, Senegal, and has unfolded plans to expand its banking operations to 15 additional countries in African.

UBA is the only sub-Saharan Bank with dual presence in the U.S and the UK. It is under the direction of its G.M.D/C.E.O; Phillip Oduza the management team of the group is made up of people with skills in various backgrounds as well as depths of experience.

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