1.1 Introduction
Exchange rate refers to the price at which one currency is exchanged for another, reflecting the relative value of two currencies in the foreign exchange market (Mishkin, 2019). In Nigeria, the exchange rate is influenced by several economic factors, including oil revenue, inflation rates, monetary policies, and foreign capital flows. Exchange rate fluctuation is the variation in the value of a currency against another currency over time, which introduces uncertainty into financial transactions, investment decisions, and the overall stability of financial institutions (Ogundipe & Ojeaga, 2018).
Deposit banks in Nigeria are key intermediaries in the financial system, mobilizing savings and providing credit for personal, commercial, and industrial activities. The financial performance of these banks, measured through indicators such as return on assets (ROA), return on equity (ROE), and net profit margins, is critical for the growth and stability of the Nigerian economy (Adegbite & Alabi, 2020).
As a prelude to other parts of this study, this chapter will discuss the background upon which this study was initiated, the statement of problems that led to this study, the Aim and Objectives of the study. Others are significance of the study, scope of work, research hypothesis and questions, limitation of the study and definition of terms.
1.2 Background of Study
Historically, exchange rate fluctuation in Nigeria is closely linked to the evolution of the country's economic and financial systems. Exchange rate management has undergone significant changes since Nigeria gained independence in 1960. Initially, the Nigerian pound was pegged to the British pound, reflecting the colonial economic structure and external trade dependence (Mishkin, 2019). With the introduction of the naira in 1973, the Central Bank of Nigeria (CBN) sought to establish a stable national currency that could support domestic economic growth and international trade.
According to Ogundipe and Ojeaga (2018), the period between the 1970s and early 1980s was characterized by relative stability in exchange rates due to the fixed exchange rate system, largely supported by high oil revenues. However, the structural adjustment program (SAP) introduced in 1986 marked a turning point, as Nigeria moved towards a more market-determined exchange rate regime (Adegbite & Alabi, 2020). Deposit banks in Nigeria began experiencing the direct effects of currency fluctuation on their financial performance during this period.
Eze and Okeke (2017) stated that banks faced increased costs in servicing foreign-denominated loans, greater risks in international trade financing, and challenges in maintaining profitability amidst an unpredictable currency environment. On the other hand, some banks leveraged periods of favorable exchange rate movements to enhance earnings through foreign exchange trading, highlighting the dual impact of currency volatility on financial performance (Onwuka & Chukwuemeka, 2019).
Exchange rate fluctuation is a critical aspect of economic management, particularly for countries like Nigeria, where the economy is heavily influenced by international trade and capital movements. According to Mishkin (2019), exchange rate represents the value at which one currency is exchanged for another in the foreign exchange market, reflecting both domestic economic conditions and global financial dynamics. The stability of exchange rates is essential for maintaining the financial performance of banking institutions, as volatility introduces uncertainty in both domestic and international banking operations. It has been reported that fluctuations in exchange rates significantly affect the financial position of banks by influencing the valuation of foreign-denominated assets and liabilities, the cost of foreign transactions, and the risk exposure of banks involved in international trade (Ogundipe & Ojeaga, 2018).
Adegbite and Alabi (2020) asserted that banks operating in volatile currency environments face challenges in financial forecasting, liquidity management, and capital adequacy, which may ultimately affect profitability and shareholder value. On the other hand, favorable currency movements can temporarily improve banks' earnings, but the unpredictability of these fluctuations makes long-term strategic planning difficult (Onwuka & Chukwuemeka, 2019). Furthermore, scholars have stated that the Nigerian economy's dependency on oil revenues, combined with inflationary pressures and external economic shocks, has amplified the volatility of the naira against major foreign currencies (Central Bank of Nigeria [CBN], 2022). Banks are therefore under increasing pressure to adopt effective risk management strategies to mitigate the adverse effects of exchange rate movements on their financial performance.
Eze and Okeke (2017) affirmed that exchange rate instability is directly linked to the cost of funds, lending rates, and investment decisions of deposit banks, which in turn influence their profitability and operational efficiency. Other researchers contend that while regulatory frameworks provide some buffer against currency risks, the dynamic nature of global financial markets continues to challenge banks in Nigeria (Ibrahim & Musa, 2018). This study is set against the backdrop of understanding how exchange rate fluctuations influence the financial performance of deposit banks in Nigeria.
1.3 Statement of Problems
The fluctuation of exchange rates in Nigeria is a persistent challenge that affects the stability and profitability of deposit banks. Exchange rate volatility is influencing the cost of foreign transactions, the valuation of foreign-denominated assets and liabilities, and the overall financial health of banking institutions. Deposit banks that engage in international trade and investment activities are particularly exposed to the risks associated with rapid and unpredictable currency movements.
On the other hand, some banks experience periods of favorable exchange rate changes, which is temporarily enhancing profitability, but the unpredictability of these movements introduces uncertainty into long-term financial planning. The instability of the exchange rate is also influencing lending and investment decisions, as banks adjust interest rates and credit policies to mitigate foreign exchange risks.
Furthermore, the economic environment characterized by inflationary pressures, fluctuating oil revenues, and changing monetary policies is amplifying the challenges posed by exchange rate volatility. The cumulative effect of these factors is the potential erosion of banks' financial performance and shareholder value, which is critical for the sustainable growth of the financial sector in Nigeria. It is against this backdrop that this study seeks to investigate the impact of exchange rate fluctuation on the financial performance of deposit banks in Nigeria.
1.4 Aim and Objectives of Study
The aim of this study is to examine the relationship between exchange rate fluctuations and the financial performance of deposit banks in Nigeria.
The specific objectives of the study are:
- To determine the effect of exchange rate fluctuations on the profitability of deposit banks in Nigeria.
- To examine the influence of exchange rate fluctuations on the liquidity position of deposit banks.
- To evaluate the impact of exchange rate volatility on the operational efficiency of deposit banks.
- To recommend strategies for mitigating the adverse effects of exchange rate fluctuations on banks' financial performance.
1.5 Research Questions
The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:
- What is the effect of exchange rate fluctuations on the profitability of deposit banks in Nigeria?
- How does exchange rate volatility influence the liquidity position of deposit banks?
- In what ways does exchange rate fluctuation affect the operational efficiency of deposit banks?
- What strategies can be employed to mitigate the adverse impact of exchange rate fluctuations on banks' financial performance?
1.6 Research Hypothesis
In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.
- H01: Exchange rate fluctuations have no significant effect on the financial performance of deposit banks in Nigeria.
- H02: Exchange rate fluctuations have a significant effect on the profitability of deposit banks in Nigeria.
- H03: Exchange rate volatility significantly influences the liquidity position of deposit banks.
- H04: Exchange rate fluctuations significantly affect the operational efficiency of deposit banks.
1.7 Significance of Study
It is believed that at the completion of the study, the findings will guide banks in developing effective strategies for risk management, enhance decision-making processes, and improve operational efficiency. Also, the findings will assist deposit banks in managing foreign exchange risks and improving profitability.
Furthermore, regulators and policymakers will benefit as the study will provide information for the formulation of monetary and banking policies. In addition, customers and clients of banks will indirectly benefit as improved financial performance leads to better services and product offerings.
Lastly, researchers and academics will have a basis for further studies on exchange rate and financial sector performance.
1.8 Scope of Study
The scope of the research is focused on the impact of exchange rate fluctuations on the financial performance of deposit banks in Lagos State, Nigeria, using selected commercial banks such as First Bank Nigeria Limited and Zenith Bank Plc as case studies. The study covers a period of ten years from 2013 to 2022, during which exchange rate volatility was particularly pronounced.
1.9 Limitations of the Study
During the course of this study, there were some problems encountered which stood as limitations to the research work. Some of the limitations include:
- Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
- Financial Constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).
- Initial Cooperation Delay from Respondents: A particular limitation of this work came as a result of the respondent refusal to offer their cooperation at the initial time they were contacted. This contributed in making the success of this research study difficult.
1.10 Definition of Terms
Exchange Rate Fluctuation:
Exchange rate fluctuation is the variation in the value of a currency against another currency over time, influenced by economic factors, market demand, and government policies (Ogundipe & Ojeaga, 2018).
Deposit Banks:
Deposit banks are financial institutions that accept deposits from the public, provide loans, and engage in other banking operations aimed at mobilizing savings and facilitating financial transactions (Adegbite & Alabi, 2020).
Financial Performance:
Financial performance refers to the measurement of a bank's profitability, liquidity, operational efficiency, and overall financial health, often evaluated using indicators such as return on assets, return on equity, and net profit margins (Eze & Okeke, 2017).
Liquidity Position:
Liquidity position refers to a bank's ability to meet its short-term obligations and manage cash flow efficiently (Ibrahim & Musa, 2018).
Operational Efficiency:
Operational efficiency is the ability of a bank to minimize costs while maximizing output, productivity, and service quality (Onwuka & Chukwuemeka, 2019).
Risk Management:
Risk management is the process by which banks identify, assess, and mitigate potential financial risks, including those arising from exchange rate fluctuations (Central Bank of Nigeria [CBN], 2022).
Exchange Rate:
Exchange rate refers to the price at which one currency is exchanged for another, reflecting the relative value of two currencies in the foreign exchange market (Mishkin, 2019).
…
