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Trading Shares in the Banking Industry: What You Need to Know

Capital Market	1913 VIEWS
Capital Market
1913 VIEWS

Monday, June 24, 2019 / 9:00AM / Albert Cooper / Header Image Credit: kjmservices.com.au

There are lots of myths surrounding the investment world, and most of them are misconstrued as the truth, unfortunately. For instance, there's a misconception that surrounds the real estate business. It holds that if you invest your money in “bricks-and-mortar” business then you have a foolproof business unlikely to financially crumble. There's a lot of untruths in this statement because anything can happen in the real estate.

A real-estate bubble like the one that crippled the Lehman Brothers can drive up a crisis leading to collapse of the entire housing bubble, and in unimaginable costs. Property booms, as well as property bursts, can be experienced anywhere in the world.

Another misconception is in the gaming and discotheque world. The myth holds you shouldn’t partake in the gaming lest your risk your finances. However, that's not true. In such a business, all you need is watch out your expenses and everything else will fall into place.

The banking industry is no exception when it comes to myths. There’s the idea that when you invest in banking shares, you’re more or less already in the business of printing money. After all, that’s what banks do, right?

Large Sometimes Means Good

There is some kernel of truth in the misconception as you'll see later on. However, a credit crunch almost sunk banks in a crisis that began in 2007 all the way to 2008. For most people, banks can’t fall under a crisis or they’re virtually unsinkable investments.

If you look at it, it’s true considering when the 2007/2008 banking crisis happened, Britain and America bailed out large banks to get them back on their feet – on the premise that banks are too large to financially crumble; that they’re too big to fail.

If such a crisis ever happens in the future, there are mechanisms set in place to ensure that banks remain so steady and that shareholders will not experience any hits instead It’s the taxpayers that will. This doesn't mean that people who deposit money will not be protected when such a crisis occurs in the future. They will and including any investors and traders in the industry. Everyone will be protected.

But you can’t ignore the fact that shareholders face a risk including the bank themselves. So what are the risks they face? There is a specific risk that is unique to the banking industry. The risk portrays the danger of a financial institution marred with fraudulent activities, incompetent and economically unstable. Honest traders in the banking industry can avoid buying stocks from banks faced with “bank-specific risks”. How?

One thing you should do, especially if you are a trader or an investor looking to invest in stocks in the banking industry, is to focus on large, renowned institutions. Some of the best institutions in mind include UBS, Citigroup, and HSBC.

It’s unlikely that these renowned institutions can crumble financially due to financial misconduct or incompetence brought about by the mismanagement of finances. The said banks have elaborate internal compliance and audit functions that allow them to stand the test of time.

That notwithstanding, the average honest investor or trader can’t escape the tentacles of the “credit cycle risk” – In such a situation banks credit cycle affects the prices of the assets and funds run low bringing the institution into a fall. And the “loan book risk”. This is a situation where the bank collectively miscalculates the amount of money allocated to a number of high-risk borrowers.

When It's Time to Get Really Afraid

When the 2007-2008 crisis occurred, it had combined both of these risks and created a huge economic turmoil that crashed the banking sector – it was a disaster last experienced 70 years ago. It explains why it created an economic emergency.

Before we get to the reasons why the emergency happened, and why it was so destructive to the economy, let's go back to understanding how credit cycles in an economy.

The economy has available credit that it relies on for its daily running. This credit is safely held in a bank – In fact banks are the sole providers of the said credit. The rise and fall of this credit cycle are important for those looking to invest in the banking shares.

However, no one knows when the credit cycle will last. If anyone knew it would be possible to make quick informed decisions on when to buy and sell shares and at what time. Sadly, this is not the case. The credit cycle remains just that - a cycle and it has been running all through for the last 8 years with no particular major variations.

But most investors and traders alike agree that a credit cycle, at one point, will come to an end. That’s the economics of everything financial service industry. What people are not really sure of is whether we’re in a mid-cycle or late-cycle scenario.

Those who agree that we’re in a mid-cycle environment speculate the said cycle is providing a false sense of security to investors and traders, even shareholders. While in a real sense a credit disaster lies in waiting because all conditions are set for a complete downturn.

And for those who agree that we.re in a mid-cycle environment are of the idea agree totally different cycle compared to the late credit cycle. And that businesses with the likelihood of experiencing a fall, and which experience failures, in the long run, tend to depict the current credit cycle as a late cycle because it's a longer cycle.

If you are an investor in the banking industry, it's important to understand the credit cycle however defined. Because it is the credit cycle that triggers bankruptcy of both corporate and individual. And this has a way of affecting the banking sector:

1. When a borrower goes bankrupt, they're unlikely to pay what they owe. Eventually, banks move in to repossess their assets as a form of security. And when the value of the assets drops, banks will then scramble to dispose of them at low prices. A loss.

2. Secondly, there is the case of banks making bad loans that eventually come back to haunt them. Since most of the borrowers then prefer to go for an online alternative realistic loans lending process which is more convenient for them, They pump money into an investment and then eventually when the investment goes down wipes away all their money, it later turns out to be a bad debt.

So how can an investor discover there’s a lending bubble on the rise? It's not easy to understand and ending bubble no matter how many annual reports you get to read or understand the financial environment.

However, the best time to get really afraid is when banks invest so much in building hotels and shopping malls or generally investing in anything that screams leisure. Sometimes banks will lend out money to Latin America if you spot such lending activities time to be wary.

It's not normal for banks to be so enthusiastic about investing money on businesses that can easily be affected by the financial crisis. Sometimes banks can miscalculate how much capital is investing owner business, greatly affects the credit cycle eventually seeking taxpayer’s money to remain float when things hit rock bottom.

It's important to understand how the banking industry operates in relation to assets and liabilities before you can invest in the bank's stock, which sometimes can be profitable for anyone who's done their homework well. However, it can be detrimental to buy or sell stocks when you are unsure for the credit cycle all the products of the banking sector.

Understand the misconceptions on the language of the banks to understand how money moves, and how bad debt can affect the economy of the banking industry.

Remember, no one can predict a financial crisis. And if there's anyone who can you should worry when they retire, because that's when the next financial crisis hit. Well, because there will be no one to remember the crisis or even speak about it. This has been enduring wisdom in the financial world at least for most market veterans – for years on end.

Author the Author

Albert Cooper is a known content writer from California, USA. He writes content in different niches such as social media marketing, finance, business etc. He’s a daytime blogger and night time reader currently working as a chief content advisor for some business and finance groups.

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