A bank’s cash flow statement: Remove it or amend it!

[dropcap]A[/dropcap]lthough the cash flow statement is extensively used by the financial community in the analysis of non-financial companies, it is not at all when it comes to deposit banks as it is considered as meaningless when it is not considered as wrong.

As far as we are concerned, we consider it is wrong and, consequently, not only meaningless but also misleading which is an unacceptable situation for one of the few compulsory accounting documents.

As specialised and independent analysts, representing institutional investors, we propose an amended version of the cash flow statement for banks.

How can it be wrong?

Because contrary to the P&L or the balance sheet, the cash flow statement is an analytical document aimed at showing the drivers of the evolution of the cash balance.

As an analytical document, it is reliant on the underlying theoretical view of the business model. The issue is that the current version is based on a misconceived view of the banks’ business model.

Why is it wrong?

The underlying concept of the current cash flow statement is based on the orthodox view which states that the function of a bank consists in gathering deposits (directly or through wholesale funding and equity) and lending them out.

This view is in total contradiction with modern theories of money and banking which see banks as monetary institutions participating in the process of money creation.

Who’s right?

As stated by epistemology, it is impossible to demonstrate that a theory is true, only that it is wrong. As a consequence, “a theory is true as long as it has not been proven wrong”.

Long considered as heterodox, the inseparable modern theories of money and banking have eventually managed to impose themselves at the highest level of responsibility, namely central banking, as confirmed by the article released by the Bank of England (“Money creation in the modern economy” Quarterly Bulletin Q1 2014) or, more recently, by the Bundesbank (“The role of banks, non-banks and the central bank in the money creation process” Monthly Report April 2017), in which both regulators position themselves in favour of these theories and against the main street’s persisting misconceived view about banking.

What should be done?

Keeping an accounting document which is misleading for the stakeholders is not a viable path. International accounting bodies are left with two options: remove it or amend it.

We definitely favour the second solution while the first one would correspond to an inadmissible admission of incompetence. Last but not least, as we show at the end of this article, the analysis of the evolution of a bank’s cash balances has a predictive power.

Download our full report: http://feedback.alphavalue.com/AV_banksctstatement.pdf