Negative Operating Cash Flows -A Signal for Well-performing Commercial Banks? A quantitative correlational study of Eurozone banks

Abstract

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.