ASSESSMENT OF FOREIGN EXCHANGE RISK MANAGEMENT PRACTICE OF COMMERCIAL BANKS IN ETHIOPIA

Abstract

The aim of this paper is to assess the foreign exchange risk management practice of commercial banks operating in Ethiopia. Information was obtained from all 17 commercial banks by adopting a census research design. Open and closed-ended questionnaires were administered to all commercial banks. The questionnaires covered key aspects of foreign exchange risk management, its objectives, strategies and techniques, its domestic regulations and including the importance of risk management practices. Many of the standard tools used to hedge currency risk, such as futures, swaps and options contracts, are either not available in emerging markets or, where available, are traded in illiquid and inefficient markets, making the range of products available extremely limited. Therefore, the purpose of this study was to find out what foreign exchange risk exposures are there, what strategies and techniques are used by commercial banks in Ethiopia to manage foreign exchange risk. The analysis sought to generate descriptive statistics, percentages and frequencies. Finally the presentation of the results was done by use of frequency tables, and charts presentation. The results of the study showed that translational exposure was the most identified exposures. Matching/ Natural hedging was the most utilized strategy. Engaging in spot transactions was also widely used. Diversification whereby banks financed in different currencies and or in different markets was employed by a few banks. Some banks engaged in risk sharing strategy. Avoidance was also employed to some extent. Netting was the least used strategy. In light of the above findings, it’s imperative that banks in Ethiopia pick out best practices from each other and abroad in order to put foreign exchange exposure under control to mitigate the effects of losses due to this risk.