Economics: Barclays UK
Fluctuations or volatility in currency exchange rates is a major factor affecting the global business environment. Major fluctuations in exchange rates could potentially signify an unfriendly economic environment and create an atmosphere of uncertainty. The impact of exchange rate fluctuations echoes across several sectors of the industry with sectors such as trade, tourism and finance suffering more of a direct impact and others feeling the after-effects. Exchange rate changes thus play an important role in determining the direction of the economy (Berka & Devereux, 2014). The UK along-with most of the modern world follows a managed float exchange rate system which uses money supply and foreign exchange reserves as tools to manipulate exchange rates and contain fluctuations (Andrews, 2017). This report aims to understand the effects of exchange rate changes on Barclays Bank which is among the largest banking institutions in the UK as well as the world. This report will look at the impact of exchange rate changes on Barclays in light of the economic environment and the monetary policy in the UK.
Given Barclays’ status as one of the UK’s premier financial institutions, it is prone to the interest rate fluctuations which often result from exchange rate changes. An appreciation of exchange rates signifies a downward movement in the current account balance since UK exports are now more expensive (Alvarez, Atkeson, & Kehoe, 2009). This downward movement in the current account would have to be offset by an upward movement in the capital and financial account (He, Fayman, & Casey, 2014). In order to generate a surplus in the capital and financial account, the UK government will have to adapt an expansionary monetary policy to attract Foreign Direct Investment (FDI) thereby raising interest rates. The inflow of hot money into the economy will further increase interest rates. For Barclays, the increase in interest rates would increase deposits but decrease the demand for loans thereby limiting the Bank’s earning potential. At the higher interest rates, consumers in the UK economy would be unwilling to borrow while Barclays will be more willing to lend thereby creating an excess supply of loans in the economy (Andrews, 2017). Figure 1 (below) shows the effects of an appreciation in the exchange rate:
Graph 1: Exchange Rate Appreciation
Source: (Barro (2007)
Similarly, a depreciation in exchange rates could create an excess demand for loans and credit financing. In today’s times especially with Brexit looming, the uncertainty in the UK economy coupled with exchange rate fluctuations could limit the earning potential of Barclays. Figure 2 (below) shows the effect of a depreciation in the pound.
Graph 2: Exchange Rate Depreciation
Source: Barro (2007)
Barclays has established its presence in almost 50 countries across 4 continents. Its multinational position, while one which depicts strength does make it vulnerable to global exchange rate fluctuations in 50 different currencies. As a result of changes in exchange rates, Barclays will be exposed to 3 main types of exchange rate risk. Firstly, Barclays will be exposed to transaction risk which refers to the risk associated with cash flows of a firm. Exchange rate fluctuations could possibly mean lower receivables, higher payables and hence lower dividends for shareholders of Barclays (Papaioannou, 2006), especially due to its global presence and cross-border transactions. The transaction risk will affect the income statement of Barclays. Secondly, Barclays will be exposed to translation risk which means variations in the valuation of assets held abroad as well as foreign subsidiaries (Engel, 2016). Thus, the translation risk would signify changes to Barclays' balance sheet which could potentially be limited by accounting procedures and regulations. And finally, exchange rate changes would leave Barclays prone to economic risk. Economic risk is described as the uncertainty in determining the present value of future cash flows. Due to Barclays' foreign subsidiaries, the economic risk would be greater as there would be more exchange rate fluctuations to consider. Any downward push to Barclays' present value of future cash flows would lead to uncertainty in major business decisions since the room would have to be made to consider the risks associated with exchange rate fluctuations. These three type of exchange rate risks would result in alterations to the financial statements of Barclays, negative trends could result in a blow to the confidence of shareholders of the company and share prices as well as dividends may fall (Engel, 2016).
However, it is important to note that Barclays’ global presence would allow it to mitigate the exchange rate risk it faces since an appreciation in the Pound could mean depreciation in a basket of other currencies. The negative impact faced by Barclays in the UK could potentially be offset by the advantages to Barclays’ subsidiaries abroad especially in countries which are heavily engaged in trade with the UK. However, since Barclays has its headquarters in the UK, it would still need to apply hedging strategies in order to ensure that it can ride the wave of exchange rate changes. Among the most recommended techniques to hedge against exchange rate risk is the acquisition of assets abroad (Dohring, 2008). Barclays would be easily able to avoid transaction risk by its focus on short term transactions so that short term cash flows can be increased. Barclays would want to look at altering its debt composition towards short term debts in order to avoid any transactional changes (Barclays PLC, 2016). Barclays has a strong asset base in the UK as well as abroad which would allow it to hedge against impending exchange rate changes but the company would still have to remain on its toes to ensure that exposure to changes in exchange rates are smoothly dealt with (Snaith, Termprasertsakul, & Wood, 2017).
As a result of changes in exchange rates, Barclays would be affected by the resulting fluctuations in interest rates which could potentially dent its earning potential. Furthermore, Barclays would also be exposed to the three main types of exchange rate risk namely transaction risk, translation risk and economic risk. Despite the risks being faced by Barclays, the bank has enough assets and foreign subsidiaries to ensure that the negative effects of an appreciation of the Pound against a basket of other currencies would be offset by the positive effects as a result of the depreciation in other currencies relative to the Pound. Barclays’ global presence, while leaving it prone to global exchange rate fluctuations also allows it to protect itself from such fluctuations. However, as a result of the current uncertainty in the UK economy with the impending Brexit, Barclays would have to ensure that all measures are taken to hedge against exchange rate changes.
Alvarez, F., Atkeson, A., & Kehoe, P. J. (2009). Time-Varying Risk, Interest Rates, and Exchange Rates in General Equilibrium. The Review of Economic Studies
Andrews, M. (2017). Pound v US dollar: GBP exchange rate ticks higher as UK retail sales return to growth
. Retrieved from Express Newspapers Web site: https://www.express.co.uk/finance/city/880286/Pound-US-dollar-GBP-exchange-rate-UK-retail-sales-growth-currency
Barclays PLC. (2016). Annual Report.
Barro, R. (2007). Macroeconomics: A Modern Approach.
Boston: Cengage Learning.
Berka, M., & Devereux, M. B. (2014). Trends in European real exchange rates. Economic Policy
Dohring, B. (2008). Hedging and invoicing strategies to reduce exchange rate exposure: a euro-area perspective .
Brussels: European Commission.
Engel, C. (2016). Exchange Rates, Interest Rates, and the Risk Premium. American Economic Review
He, L. T., Fayman, A., & Casey, M. K. (2014). Bank Profitability: The Impact of Foreign Currency Fluctuations. Journal of Applied Business and Economics
Papaioannou, M. (2006). Exchange Rate Risk Measurement and Management: Issues and Approaches for Firms. Monetary and Capital Markets
Snaith, S., Termprasertsakul, S., & Wood, A. (2017). The exchange rate exposure puzzle: The long and the short of it. Economics Letters