Foreign Exchange And International Trade Its Effect On Bank Profitability
This project is titled foreign exchange and international trade it’s effect on bank profitability. It examines the extent and effect of foreign presence in domestic banking markets. It investigate how net interest margins, overhead tax paid and profitability differ between foreign and domestic banks we find that foreign banks have higher profit than domestic bank in developing countries but the opposite is the case for developed countries. Estimation result suggest that an increased presence of foreign bank is association with a reduction in profitability and margins for domestic banks are regard to foreign exchange and international trade.
1.1 Background of the Study
In recent decades, international trade in goods and financial services has become increasingly important. To facilitate such trade, many banking institution have also become international.
Foreign exchange market (currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centres around the world function as auchors of trading between a wide range of different types of buyers and sellers around the clock.
The foreign exchange market determines the relative valve of different currencies.
The foreign exchange market assist international trade and investment by enabling currency conversion for example, it permits a business in Nigeria import goods from European union member states especially Eurozone members and pay Euros. Ever through its income is in Nigeria. It also support direct speculation in the valve of currencies and the carry tradE, speculation basat on the interest rate differential between two currencies.
In a typical foreign exchange transaction a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrict on foreign exchange transaction (the Bretton wood system of monetary management established the riles for commercial and financial relations among the world’s major industries states after world war II) when countries gradually switched to floating exchange rate from previous exchange rate regime which remained fixed as per the Bretton wood system.
The foreign exchange market is unique because of the following characteristics.
- Its huges trading volume representing the largest asset class in the world leading to high liquidity.
- Its geographical dispersion
- The variety of factors that affect exchange rates
- Its continuous operation hours a day except weekend i.e trading from 20:15 GMT on Sunday until 22:00 GMT Friday.
- The law margins of relative profile compared with markets of fixed income.
- The use of leverage to enhance profit and loss margins and with respect to account size.
As such it has been referred to as the market closest to the ideal of perfect competition not withstanding currency intervention by central banks. According to the bank for international settlement as of April 2010, average daily turnover in global foreign exchange market is estimated at $3.98 trillion a growth of approximately 20% over the %3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US $4 trillion.
Banks have expanded internationally by establishing foreign subsidiaries and branches or by taking over established foreign banks. The internationalization of the banking section has been spurred by the lateralization of financial market worldwide. Developed and developing countries alike now increasingly allow banks to be foreign owned and allow foreign entry on a nation treatment basis.
Financial liberalization of this kind of proceeds, among other reasons on the premise that the gains from foreign entry to the democratic banking system out weight any losses several authors have addressed the potential benefits of foreign bank entry for the domestic economy in terms of better resource allocation and higher efficiency Levine (1996) specifically mention that foreign bank may:
- Improve the quality and availability of financial services in the domestic financial market by increasing bank competition by enabling the greater application or more modern banking skills and technology.
- Serve to stimulate the development of the underlying bank supervisory and legal framework.
- Enhance a country’s access to international capital. There may also be cost to opening financial market to foreign competition stightz (1993) for instance discusses the potential costs to domestic banks local entrepreneurs and the government resulting from foreign bank entry.
Domestic banks may incur costs they have to compete with larger international bank with better reputation local entrepreneurs may receive less chess to financial service since foreign generally concentrate on multinational firms and government may find their control of the economy diminished since foreign banks tend to be less sensitive to their wishes.
As yet little evidence exist of the effects of an internationalization of the banking sector other than several case studies of foreign bank entry MC Fadden (1994) reviews foreign bank entry in Australia and finds that this has led to improved domestic bank entry operations. Bhattacharaya (1993) reports on specific cases in Pakistan, Turkey, and korea where foreign banks facilitated access to foreign capital for domestic project pigott (19986) describe the policies that have made increased foreign bank activity possible in nine pacific Basin countries and provides some aggregate statistics on the size and scope of foreign banking activities in these markets.
1.2 Statement of Problem
The statement of problem of the research work is to discuss the effect of foreign exchange and international trade on bank profitability. The importance of international trade in the development process has been of interest to development economists and policy makers alike. Imports and exports are a key part of international trade and the import of capital goods in particular is vital to economic growth. This is so because imported capital goods directly affect investment, which in turn constitutes the motor of economic expansion. Economic reform is expected to affect imports as part of the strategy to restore balance.
In Nigeria, some people are in favor of protectionist and highly regulated economy and have even criticized the previous Nigeria government for signing the treaty of World Trade Organization, claiming that, Nigeria was not adequately represented in the negotiations and that we should push for a fairer deal.
The research questions which will guide this work are as follows. Do foreign exchange affect bank profitability? Do international exchange affect profitability?
1.3 Objectives of the Study
The researcher’s aims is to provide a systematic study of how banks profit from foreign exchange and international activities. However, the objective of the study are as follows:
- To know the effect of foreign exchange on bank profitability
- To know the effect of international trade on bank profitability
- To know the size and scope of foreign banking activities.
- To know the quality and availability of financial services in the domestic financial market by increasing bank competition.
- To know the use of leverage to enhance profit and loss margins and with respect to account size.
1.4 Research Questions
- Do foreign exchange affect bank profitability?
- Do international exchange affect profitability?
- Do foreign exchange and international trade affect the size and scope of foreign banking activities?
- Do foreign exchange and international trade affect the quality and availability of financial services in the domestic financial market by increasing bank competition?
1.5 Significance of the Study
This work will be immense bat to the economy of the country at large. It will serve as a guard to students of banking and finance who wish to carry out the same research. In as much as Nigeria has benefited from foreign trade, it has also felt a negative impact of foreign trade. This is because of the fact that, Nigeria is not industrialized, hence Nigeria imports much more than it exports. This has caused and advance balance of payment (B.O.P). This study will also help to a large extent to
- Boost the production capacity of small and medium scale industries. The resultant effect being the increase in output for increased export.
- Initiate large–scale industrial projects
- Spell out the need for more allocation of the economy
- Increase the capacity utilization of small scale manufacturing industries hence, encouraging demand for foreign goods
- Discouraging too much importation, especially, on consumer goods
Finally it will of importance to the banking because it proffers ways on how bank can increase their profit through foreign exchange and international trade.
1.6 Scope and Limitations of the Study
The scope of the study will span a period of years focusing on foreign exchange and international trade, its effect on bank profitability. The empirical analysis shall focus on the impact of international trade on bank profitability. In the course of the study, the researcher encounters some constrain which limited the scope of the study;
Availability of Research Material:
The research material available to the researcher is insufficient, thereby limiting the study
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.
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
This may be defined as theexchange of goods and services between two or more countries.
Is seen as the transfer of bankdeposits and credit instruments that serves as a means of international payment.
My be defined as a financial institution wheremoney and other valuables are kept for safe keeping.
This may be defined as the moneythe bank earn from the fees that it charges for its services and the interest that it’s earn on its asset.
Effect is defined a change which is a result or consequence of an action or other cause or cause (something) to happen; bring about.
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), 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 the 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
Summary Conclusion and Recommendation
It is pertinent to note that this research was aimed at examining the effect of foreign trade in Nigeria, thus the topic “foreign exchange and international trade; it effect on bank profitability”.
In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges associated with foreign exchange rate and bank profitability in Nigeria.
The objective of this study was to determine the effect of foreign exchange and international trade, its effect on banks profitability. The study found out that a negative relationship existed between foreign exchange and the financial performance of banks as measured by the returns on assets ratio. The research findings further revealed that the strength of association between the fluctuations and the returns was a weak one.
Banks were observed to be profitable at a time when the economy was bad whereby other sectors were experiencing difficulties in remaining afloat. The banking industry benefits in such times since the interest rate spread and inflation are high.
The observed relationship could have been attributed by the differences between trading currency and financial reporting currency. Results from the study revealed that a fluctuation in the value of the domestic currency led to a negative effect on the financial performance of the banks. However the research findings as under the banking sector concurred with research findings from other sectors, for instance. Ambunya (2012) had examined the relationship between exchange rate movement and stock market returns volatility at the Nairobi Securities Exchange. The study revealed that exchange rate movement also affects the stock market performance greatly especially through its spiral effects. Gachua (2011) also observed that unrealized foreign exchange gains or losses had an effect on the net income of listed companies as it was posted to either income statement or owners` equity.
The Nigerian USD exchange rate was observed to have really increased over time thus the high volatility over time. The exchange rate was volatile for the entire study period and generally exhibited a depreciating and volatility trend, implying that in general, the country’s international competitiveness had deteriorated over the study period.
The Nigerian Naira has simply been losing to the US dollar over the entire study period. This has negatively influenced the Nigerian banking sector and the general economy by making the cost of living expensive since the country heavily relies on imports. The findings however agree with Owoeye, and Ogunmakin (2013) who observed through their study model that the impact of exchange rate on bank performance was sensitive to the type of proxy being used for bank performance. Therefore, commercial banks in Nigerian are exposed to foreign exchange trade risks that negatively affects their performance.
This study explored the effects of inflation rates, interest rate spread, foreign exchange rate fluctuations and size of the banks on the performance of commercial banks in Nigeria. From the research findings, the study concluded that there is a weak negative relationship between foreign exchange rate fluctuations and the performance of commercial banks in Nigeria. Additionally, the Nigerian shilling exchange rates against the United States Dollar was observed to be really high during the study period. In essence, the NigerianNairahas been depreciating in values against the dollar over the recent years and this depreciation has had a negative impact on the returns of commercial banks in Kenya. The researcher also concludes that total assets owned by commercial banks and the inflation rates were increasing over the years. With regards to the inflation rate, the conclusions are that the inflation rates have been increasing yearly over the entire study period. The relationship however between inflation and returns on assets was negative and hence it negatively impacted performance. The difference in rates termed as interest rate spread had a negative relationship with returns on assets. The study concludes that interest rates especially lending rates have been increasing over time whereas the same observation was not eminent in deposit rates by banks. The study therefore concludes that the interest rates spread has been increasing in the recent years since borrowing had become expensive thus profitable whereas deposits rates were very small. This therefore translated to higher returns by banks since customers pay more and earn less when they make deposits in banks.
- This study suggest that the government should deploy adequate measures to safeguard the domestic currency. It should promote foreign direct investments so as to spur economic growth and consequently cause the local currency to appreciate. This would translate to a more stable currency against international currencies. This would consequently lower borrowing costs thus making loans even more affordable.
- The relevant authorities for instance The Central Bank of Nigeria should adequately put measures to safeguard the value of the domestic currency. This would ensure that the value on the same does not fluctuate much day in day out.
- The Central Bank of Nigeria ought to implement efficient monetary and fiscal policies so as to help curb significant deficits in balance of payments. 4. The government at large should deploy measures that are aimed at increasing the national income of the country based on investments funded locally.
- International funding should be limited to small extent so that the domestic currency can be strong in the international money markets.
- The government should put measure to curb the rising of inflation in double digits. Banks Management in Nigeriashould adopt hedging strategies so as to mitigate against foreign exchange risks since it affects the performance of the banks in Nigeria.
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