Forex volatility a blessing in disguise for banks

Thursday May 16 2019

 

On 6th May, 2019 it was published in this paper that the closure of bureaux de change in some cities in Tanzania was the reason for a significant increase in income from forex trade for banks during the first quarter of 2019, citing an increase of 70 per cent for the period.

Whilst there might be a link, albeit weak, between the closure of bureaux and increased earnings by the banks, I believe the main reason for the increased earnings was the volatility of the shilling against major currencies.

During the first three months of this year, we saw a sharp depreciation of the shilling against the US dollar to a low of about Sh2,440 before bouncing back to around Sh2,300, a fluctuation of 6 per cent in a single quarter versus a depreciation of around 5 – 7 per cent per year experienced over the past decade.

To elaborate, volatility in foreign exchange often creates panic to those that depend on foreign currency to transact, such as those with cross border transactions.

Panic would then lead to increased volumes of trade even when the foreign currency is not immediately needed because companies would want to hedge against the perceived further depreciation of the local currency. This phenomenon is often referred to as front loading of demand.

In the case of the shilling, the artificial demand of the US dollar pushed high the exchange rate of the shilling against the dollar due to increased demand of the dollar – laws of demand and supply.

Going back to the banks, the most recently published quarterly financial statements of 10 largest banks by assets dated 31st March, 2019 show a combined income of Sh65.5 billion from forex transactions compared to Sh45.9 billion for the same period last year, an increase of 43 per cent.

We seem to have passed the tumultuous patch in the weakening of the shilling as the shilling has been relatively stable in recent weeks.

Therefore, I would expect lower earnings from foreign exchange to be reported by banks in the second quarter although bureaux still remain closed. The truth will be known after publication of the second quarter results.

In conclusion, it is important for businesses that deal in or depend on foreign exchange to act rationally by not reacting to unexpected movements in exchange rate. Furthermore, one should obtain independent exchange rate figures before agreeing to an exchange rate given by a particular bank including our own bankers. Obtaining expert advice is also recommended and can save money.

Mr Godfrey Mramba is Managing Partner at Basil & Alred. The views expressed do not necessarily represent those of Basil & Alred

Advertisement