FOREIGN EXCHANGE RISK MANAGEMENT PRACTICES BY FOREIGN OWNED

COMMERCIAL BANKS IN KENYA

This research endeavored to achieve three objectives: to ascertain the foreign exchange

risk management practices of foreign owned commercial banks in Kenya, to determine

the extent of foreign exchange risk management by the banks and to rank the

ascertained practices in order of importance. Empirical evidence was extensively used to

link the findings of the study with prescriptions of academic literature. The study focused

on the head offices of the twelve foreign owned banks in Kenya out of which nine

responded.

The research was an exploratory study carried out as a census survey. Qualitative

primary data was used for the study. Self-administered questionnaires were delivered to

the treasury departments of the banks using 'drop and pick later' technique. Descriptive

statistics were used to analyze the data.

Various inferences were drawn from the findings; the responding banks employed both

conventional and bank-specific foreign exchange risk management practices. Most banks

considered credit/default risk to be the most critical of all financial risks though empirical

evidence shows that foreign exchange risk is the most critical risk for most firms. A

strong majority of the banks did not find the Kenyan currency market to be information

efficient: speculation and forecasting techniques were extensively used by most of them.

The banks' views on market fundamentals and what constitutes foreign exchange risk

management best practices had a significant bearing on hedging practices adopted.

Regular and systematic appraisal of exchange risk management policies was a common

practice amongst most banks. For most banks, foreign exchange risk management

systems were governed by guidelines set at the head office (highly centralized foreign

exchange risk management systems).

The findings from most banks were similar to empirical evidence but considerably
inconsistent with recommendations of literature. Most banks, regardless of their size,

extensively utilized most of the conventional hedging instruments. Micro hedge approach,

accounting, translation and economic exposure measurement strategies, natural hedging,

risk sharing and diversification were some of the most utilized strategies. Transaction

exposure was rated as the most critical to most banks when compared to translation and

economic exposures. Some hedging practices were considered by most banks to be the

more important than others. These include use of forward contracts and foreign currency

options as hedging instruments, use of matching/natural hedging strategy and preference

of selective hedging strategy instead of hedging all positions immediately. The extent of

foreign exchange risk management by the banks was also gauged: it emerged that most

banks practiced foreign exchange risk management to some extent.

This research will make a contribution to the academic literature on the field of foreign

exchange risk management in Kenya where very little is known about corporate practice in

the banking sector due to few studies in the subject. The findings and conclusions of the

study will also make a contribution towards unravelling the intricacies surrounding the

discrepancies between academic literature on financial risk management and corporate

practice.