'An Assessment of Asset and Liquidity Quality As Indicators of Performance Within the European Banking Sector'
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‘An assessment of asset and liquidity quality as indicators of performance within the European banking sector’ Eva J. Gleeson MSc in Management National College of Ireland, IFSC Submitted to the National College of Ireland, September 2015 1 Submission of Thesis and Dissertation National College of Ireland Research Students Declaration Form (Thesis/Author Declaration Form) Name: Eva J. Gleeson Student Number: x13117114 Degree for which thesis is submitted: MSC Management Material submitted for award (a) I declare that the work has been composed by myself. (b) I declare that all verbatim extracts contained in the thesis have been distinguished by quotation marks and the sources of information specifically acknowledged. (c) My thesis will be included in electronic format in the College Institutional Repository TRAP (thesis reports and projects). (d) Either *I declare that no material contained in the thesis has been used in any other submission for an academic award Or *I declare that the following material contained in the thesis formed part of a submission for the award of MSC Management (State the award and the awarding body and list the material below) Signature of research student: Eva J. Gleeson Date:31//08/2015 2 Submission of Thesis to Norma Smurfit Library, National College of Ireland Student name: ______________________________ Student number: __________ ___ __ School: ___________________________________ Course: __________ ______________ Degree to be awarded: __________________________________ _____________ _ __ Title of Thesis: __________________________________________________________ ___ _______________________________________________________________________ __ _______________________________________________________________________ __ One hard bound copy of your thesis will be lodged in the Norma Smurfit Library and will be available for consultation. The electronic copy will be accessible in TRAP (http://trap.ncirl.ie/), the National College of Ireland’s Institutional Repository. In accordance with normal academic library practice all theses lodged in the National College of Ireland Institutional Repository (TRAP) are made available on open access. I agree to a hard bound copy of my thesis being available for consultation in the library. I also agree to an electronic copy of my thesis being made publicly available on the National College of Ireland’s Institutional Repository TRAP. Signature of Candidate: ______________________________________________________ For completion by the School: The aforementioned thesis was received by___________________ Date:_______________ 3 Abstract Almost a decade after the initial impact of the 2008 financial crisis, questions remain regarding the fundamentals of the European banking sector. This study investigates the relationship between asset quality and liquidity, and their impact on European bank performance. A longitudinal analysis is conducted using a number of financial ratios for the time period of 2009 to 2013. A non parametric method (Kruskal-Wallis H test) is employed in order to measure the impairment, liquidity and profitability of six hundred and twenty six banks against a European Central Bank benchmark. The results find statistically significant evidence to suggest that the impairment level is affecting the performance in the larger asset banks. However, the liquidity level appears to affect the larger asset class only when subject to external market factors such as a low net interest environment. When combining both poor asset and liquidity quality, the findings suggest that the larger asset banks are more affected by impairment quality and can absorb a poorer liquidity result provided normal market conditions prevail. The impact of impairment quality appears to differ when assessing the non large banks. These banks show a capacity to absorb bad debt losses, despite a growing percentage of impairment. This was an unexpected finding and indicates the relationship between performance and impairment differs, dependent on asset size. This also suggests that impairment as an indicator of performance is subject to certain caveats. Liquidity quality appears to impact the non large banks in a manner comparable to the large banks. This would suggest that the non large asset class can also absorb a combination of both poor impairment and liquidity results under normal market conditions. The empirical evidence presented can be used as a benchmark and a basis for further investigation into the factors that impact on European bank performance. 4 Acknowledgements I acknowledge with thanks the assistance of: Dr Garvan Whelan [CPA PhD] School of Business and Humanities IT Tallaght, Dublin 24 Mr. Jonathan Lambert National College of Ireland Mayor Street, IFSC, Dublin 1 Mr. Andrew Pollock Chief Risk Officer (CRO) Western Union Payment Services Ireland Limited Clonskeagh, Dublin 14 Mr. Emmanuel Salvetti Chief Creditor Officer (CCO) and Vice President of Risk and Credit Finance Western Union International Englewood, Colorado, US Mr. Alberto Bellocchi Global Head of Credit and Vice President Western Union International Milan, Italy 5 Dedication There are a number of people without whom this dissertation might not have been written, and to whom I am greatly indebted. I would like to thank my family; my parents, brother and sister for their unconditional support and continuous encouragement throughout my life and education. I give special thanks to Pavel Remen, Jacinta McHenry and Damien Mulholland for your absolute confidence in me. I would also like to thank my friends and colleagues at Western Union; Dara, Ciara, Andrew, Alison, and Louise whose constant care, support and encouragement not only motivated but inspired me. In particular, I would like to dedicate this dissertation to Cliff Carter. Without his unending positivity, support and kindness, this would not have been possible. 6 Contents Declaration………………………………………………………………………………………… 2 Abstract……..……………………………………………………………………………….......... 4 Acknowledgements……………………………………………………………………………….. 5 Dedication…………………………………………………………………………………………. 6 Table of Contents………………………………………………………………………………… 7 List of Tables………………………………………………………………………………………. 10 List of Figures……………………………………………………………………………………... 13 List of Abbreviations……………………………………………………………………………… 15 I. Introduction……………………………………………………………………………………... 16 II. Literature Review………………………………………………………………………………. 19 II.i Introduction to Literature……………………………………………………….. 19 II.ii Specific bank measurements, frameworks and the importance of asset and liquidity quality on profitability…………………………………………….. 21 II.iii The banking sector - indicators of asset quality, liquidity, profitability and codependence…………………………………………………………………… 22 II.iv The interaction of asset, liquidity and profitability quality and the measurements of performance………………………………………………… 24 II.v Recent significant banking policies and bank size…………………………... 25 II.vi International Financial Report Standards and the significance of financial statements within research and performance evaluation…………………… 28 II.vii Existing Literature and classical theories……………………………………... 29 II.viii Recent Literature and the incorporation of ratios……………………………. 30 II.ix Performance, bank stability and the Return on Equity in this study……….. 33 III. Methodology…………………………………………………………………………………… 34 III.i Data sample……………………………………………………………………… 35 Bankscope……………………………………………………………………... 35 Size……………………………………………………………………………... 36 III.ii Data analysis, validity and reliability…………………………………………... 37 Independent variables used in this study…………………………………… 37 Dependent variable used in this study……………………………………… 38 III.iii Approach adopted………………………………………………………………. 38 7 IV. Analysis and discussion……………………………………………………………………… 40 IV.i Key performance indicators and trends: descriptive statistics Impairment……………………………………………………………………..... 40 The full asset sample………………………………………………………40 The large and non large asset samples………………………….……… 45 Liquidity………………………………………………………………………… 48 The full asset sample……………………………………………………… 48 The large and non large asset samples…………………………………. 51 Performance…………………………………………………………………… 55 The full asset sample……………………………………………………… 55 The large and non large asset samples…………………………………. 58 IV.ii Impairment and liquidity as indicators of performance……………………… 60 Impairment…………………………………………………………………….. 60 Basel II and bank size……………………………………………………... 60 Bank size and regulation……………………..…………………………… 61 Bank size and management……………………………………………….61 Liquidity………………………………………………………………………… 62 Basel II………………………………………………………………………. 62 The cost of bad debt……………………………………………………….. 63 The cost of borrowing and the current interest rate environment…….. 63 Performance…………………………………………………………………… 64 IV.iii Impairment, liquidity and the strength of the relationship with bank performance……………………………………………………………….. 65 IV.iv An assessment of asset and liquidity quality as indicators of performance within the European banking sector…………………………… 67 Presentation of the research results: The Kruskal – Wallis H test outcome………………………………………………………… 68 IV.v Impairment……………………………………………………………………….. 70 Central Bank impairment and performance (full sample split by years)… 70 Central Bank impairment and performance (large class asset sample split by years)………………………………………………………………….. 74 Central Bank impairment and performance (non large class asset sample split by years)………………………………………………………… 77 IV.vi Impairment as an indicator of performance…………………………………... 80 8 The full and