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Negative Operating Cash Flows – a Signal for Well-Performing Commercial Banks?

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Negative Operating Cash Flows – a Signal for Well-Performing Commercial Banks? View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Göteborgs universitets publikationer - e-publicering och e-arkiv Negative Operating Cash Flows – A Signal for Well-performing Commercial Banks? A quantitative correlational study of Eurozone banks School of Business, Economics and Law Bachelor’s thesis in Accounting Department of Accounting Course FEG313. Spring term 2014 Tutor: Gudrun Baldvinsdottir Authors: Adam Färnemyhr , 920919 Joakim Lundström, 911130 Acknowledgements Warm thanks to Professor Gudrun Baldvinsdottir for superb guidance and insightful advice on research topic. We would also like to acknowledge Ásgeir Torfason who shared his dissertation with us before it was officially published. And finally, we are pleased to extend our gratitude to the librarians who supported us with data collection from databases. Gothenburg, May 26 2014 ______________________ _______________________ Adam Färnemyhr Joakim Lundström Abstract Bachelor’s Thesis in Accounting, School of Business, Economics and Law at the University of Gothenburg, spring term 2014 Authors: Adam Färnemyhr and Joakim Lundström Tutor: Gudrun Baldvinsdottir Title: Negative Operating Cash Flows – A Signal for Well-performing Commercial Banks? Background and problem discussion: Commercial banks are essential since they maintain and restore the stability in the economy. Thus, it is important to measure the performance of commercial banks. One key aspect in the analysis of the performance of companies is the cash flow statement. However, it is not used to analyse banks. Many of the largest Scandinavian commercial banks had negative operating cash flows for several consecutive years without suffering any liquidity issues. This phenomenon can be explained by the fact that commercial banks sell cash. A well-performing bank creates an outflow of cash since it sells more and more cash through lending. Consequently, it should be logical that well-performing commercial banks have negative operating cash flows due to increased lending. Purpose of the Study: This paper aims to study whether negative operating cash flows signal increased lending and, hence, improved performance for commercial banks. This thesis, also, intends to investigate if there are any differences between the correlations between the studied countries and, if so, why these differences arise. Furthermore, the purpose of this thesis is also to analyse the reasons behind the most extreme correlations found in the sample. Methodology: A hypothesis was derived by using a deductive approach. This hypothesis was tested through a quantitative correlational study between operating cash flows and return on equity for 39 commercial banks. The six banks with the most extreme correlations were studied more thoroughly. All the studied banks were from the original eleven Euro Area countries. They had to be active, listed and applying IFRS. The banks in this study cover more than 80% of all the banks that fulfilled the criteria above. Data was collected from the period 2005-2012. Empirical findings: The result of this thesis illustrates that slightly more than 50% of the commercial banks have a negative correlation between operating cash flows and return on equity. When studying the commercial banks with the most extreme correlations, four of six had negative correlations between change in lending and operating cash flows. The empirical findings also address similarities in correlation for commercial banks within countries and differences between countries. Conclusions: It cannot be statistically confirmed that there exists a negative correlation between return on equity and operating cash flows. Hence, the hypothesis can be rejected. This thesis has also illustrated that there may be common patterns in terms of cash flow reporting within countries, but these patterns may differ between countries or regions. It is difficult to clearly state why these patterns arise, they may be arbitrary but there is also a possibility that they depend on differences in accounting practices in each country. The disparate practices emerge as a result of the flexibility in the accounting standard IAS 7. Keywords: IAS 7, statement of cash flows, operating cash flows, return on equity, correlation, financial institutions, commercial banks, cash flow accounting, comment letters. Table of Contents 1. Introduction .......................................................................................................................... 1 1.1 Background ...................................................................................................................... 1 1.2 Problem Discussion .......................................................................................................... 2 1.3 Purpose of Study .............................................................................................................. 2 1.4 Research Question ............................................................................................................ 3 1.5 Limitations ....................................................................................................................... 3 1.6 Abbreviations ................................................................................................................... 4 2. Research Methodology ......................................................................................................... 5 2.1 Approach .......................................................................................................................... 5 2.2 Research Design ............................................................................................................... 6 2.3 Data Collection ................................................................................................................. 7 2.3.1 Selection of Countries ............................................................................................... 7 2.3.2 Selection of Commercial Banks ................................................................................ 8 2.3.3 Analysis of Missing Data .......................................................................................... 8 2.4 Empirical and Analytical Method .................................................................................... 9 2.5 Validity and Reliability .................................................................................................. 10 2.6 Source Criticism ............................................................................................................. 11 3. Theoretical Framework ..................................................................................................... 12 3.1. The Importance of the Cash Flow Statement ................................................................ 12 3.2 Comment Letters - Cash Flow Statements in Banks ...................................................... 12 3.3 IAS 7 - Statement of Cash Flows ................................................................................... 14 3.3.1 Objective, Scope and Benefits ................................................................................ 14 3.3.2 Presentation of a Statement of Cash Flow............................................................... 15 3.3.3. Flexibility regarding IAS 7 .................................................................................... 16 3.3.4. Specific Exceptions for Financial Institutions ....................................................... 17 3.4 Previous Research .......................................................................................................... 17 3.4.1 Cash Flow Accounting in Banks ............................................................................. 17 3.4.2 Credit Creation ........................................................................................................ 19 4. Empirical Findings and Analysis ...................................................................................... 21 4.1 Empirical Findings and Analysis of Correlations .......................................................... 21 4.2 Empirical Findings and Analysis of Outliers ................................................................. 22 4.2.1 Banca delle Marche ................................................................................................. 22 4.2.2 CaixaBank ............................................................................................................... 23 4.2.3 BNP Paribas ............................................................................................................ 24 4.2.4 Banca Monte dei Paschi di Siena ............................................................................ 25 4.2.5 Bank of Ireland ........................................................................................................ 25 4.2.6 LeasePlan Corporation ............................................................................................ 27 4.3 Empirical Findings and Analysis of the Differences between Countries ....................... 28 5. Conclusions ......................................................................................................................... 33 5.1 Contribution of the thesis ............................................................................................... 34 5.2 Recommendations for further research .......................................................................... 35 5.2.1 Origins of operating
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