A Study on Exchange Rate Exposure of Chinese Banks

Abstract: For banks to adjust to the changing financial environment, it is essential to understand how the foreign exchange market impacts them. The purpose of this master thesis is to evaluate the effect of exchange rates movement on fourteen listed Chinese banks’ equity returns, by using the Arbitrage Pricing Theory Model. In particular, this paper analyses the three foreign currencies holding the largest trading position with China, namely the Euro, US Dollar, and Japanese Yen. This empirical study finds that Chinese banks are on average most sensitive to RMB exchange-rate movements with regards to Japanese yen. It is also found that foreign exchange exposure has some relation to bank size, with foreign exchange risk being most prominent for medium size banks, than for larger banks. This study tests the foreign exchange rate risk faced by Hong Kong banks, and finds that Hong Kong banks display a much larger exposure than Chinese banks face. In all, this study determines that foreign exchange rates do have an effect on the Chinese banking sector.