Bank Profitability: The Impact of Foreign Currency Fluctuations (original) (raw)
Given the global nature of business, and in particular banking, we should find that financial institutions are impacted by foreign currency movements. In this paper, we investigate whether the performance of 22 large U.S. commercial banks is affected by foreign exchange fluctuations over a 40-year period. We find that these large U.S. banks are exposed to foreign exchange risk and that specific bank performance is related to the value of the dollar relative to market baskets of other currencies. These results can potentially be used to mitigate some of this risk and/or alter investment portfolios given various foreign currency movements. INTRODUCTION AND LITERATURE REVIEW The popular press contains numerous references to the impact of foreign exchange movements on U.S. banks. For example, in an article by Boyd (2011) he states that Fitch Ratings indicated that U.S. banks had substantial exposure to the Euro related to the European debt crisis. In fact, by the end of 2010 the combined U.S. bank exposure to the Greek debt crisis alone was at least 41billionaccordingtotheBankofInternationalSettlements.AdditionaldatafromtheOfficeoftheComptrolleroftheCurrency(OCC)indicatesthatU.S.banksgeneratesubstantialtradingrevenuefromforeignexchange.Inthesecondquarterof2011,therevenuefromforeignexchangewas41 billion according to the Bank of International Settlements. Additional data from the Office of the Comptroller of the Currency (OCC) indicates that U.S. banks generate substantial trading revenue from foreign exchange. In the second quarter of 2011, the revenue from foreign exchange was 41billionaccordingtotheBankofInternationalSettlements.AdditionaldatafromtheOfficeoftheComptrolleroftheCurrency(OCC)indicatesthatU.S.banksgeneratesubstantialtradingrevenuefromforeignexchange.Inthesecondquarterof2011,therevenuefromforeignexchangewas491 million. However, in comparison with the second quarter of 2010 the U.S. bank revenue from foreign exchange was $4,261 million. The year-to-year volatility highlights the risk exposure of U.S. banks to foreign exchange movements. When the derivative exposure is added to this equation, the amounts of risk attributable to foreign exchange can be staggering with many estimates ranging in the hundreds of billions of dollars (Durden, 2011). Given the recent popular press attention to foreign exchange risk of big commercial banks it warrants academic investigation. Is bank performance truly impacted by foreign exchange risk? The purpose of this research is to investigate that claim using 30 years of recent data to evaluate the exposure of large U.S. banks to fluctuations in foreign exchange. A number of academic studies have addressed banks and foreign exchange exposure. For example, Bracker et al (2009) identified the change in the value of the U.S. dollar as one of the six primary sources
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