Foreign exchange fluctuations and commercial banks profitability in Nigeria

Abstract

The importance of examining the effect currency fluctuation has on commercial banks profitability cannot be over emphasized, particularly, given this era of Global financial integration. Most commercial banks are said to suffer from erosion of their profit arising from their exposure to fluctuations in international currencies, especially, when proper hedging strategies are not adopted. This study used the balanced panel methodology and data obtained from 12 largest banks in Nigeria to examine the relative effect of currency fluctuation on commercial banks profitability. In other to get the independent effect of currency fluctuation on commercial banks profitability the study also introduced four bank characteristic variables (bank size, bank divestment, non-performing loans and capital adequacy ratio) into the model. The initial result without the bank characteristic variables revealed that the dollar and pounds exerted a 6 percent and 11 percent negative effect on commercial banks profitability respectively. Introduction of the bank specific variables into the model saw the magnitude of the currency fluctuation reduced by 1 percent and 5 percent for the dollar and pounds respectively. More specifically, bank characteristic variables, banks size and capital adequacy exerted positive significant effect on commercial banks profitability while non-performing loans and bank divestment exerted a negative effect on commercial banks profitability. The study therefore recommended that banks should increase their divestment options as well as switch their trading options to the less volatile currency (as a measure of hedging against currency risk) in periods of severe currency fluctuations.

Key words. Banks profitability, capital adequacy ratio, currency fluctuation, exchange rate risk.