THE IMPACT OF FOREIGN CURRENCY EXCHANGE FLUCTUATION ON THE FINANCIAL PERFORMANCE OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA

Abstract

Banks played significant role in the foreign exchange market, the international trade involves different currencies; the variability of foreign exchange rates is an interesting factor that drives the level of profitability of commercial banks as it affects their financial intermediation process. This research was aimed to examine the impact of foreign currency exchange fluctuation on financial performance of private Commercial Banks in Ethiopia. It attempts to identify how foreign exchange rate along with interest rate spread , inflation rate and bank size affects financial performance measured by return to Equity (ROE). In order to satisfy the objective of the study the researcher used quantitative research approach by adopting purposive sampling technique and explanatory type of research design. The samples used for this study were secondary data for a period of 20 years starting from 2000 through 2019 for a cross section of 6 private commercial banks; these data were mined from the audited annual financial statement of banks, NBE annual bulletins and ministry of trade. The study tested for the assumptions of CLRM. Random Effect Regression model has been used to analyze the results. The study used Stata 13 econometric software package to aid in data analysis. An econometric model was used to examine the relationship between foreign exchange rate, interest rates spread, inflation rates and bank size with bank performance indicators. Outcomes of the study revealed for the existence of a negative and significant relationship between foreign exchange rates and financial performance of private commercial Banks, a positive and significant relationship between bank size and financial performance of private commercial banks. The study concluded that there was insignificant relationship among interest rate spreads and inflation rates with the financial performance of private commercial banks in Ethiopia in the study period. The study recommends that the Government should put up more measures to increase the country’s exports and foreign direct investment and the National Bank of Ethiopia 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 and Banks Management in Ethiopia should adopt appropriate strategies so as to mitigate against foreign exchange risks.