According to Warren Buffett, the first rule of investing is to avoid losing money. The only way to do this is to understand the risks and what could go wrong when finding shares to buy.
Right now, shares in UK banks are trading at some really attractive prices. But while I think this could be a great opportunity, it looks to me like the risks involved are both real and significant..
Risks
First of all, let’s get clear on what the risks are and why investors should take them seriously.
In the short term, the biggest risk facing UK banks is that a liquidity crisis might cause them to fail. If that happens, it would be a disaster for shareholders.
I’ve heard two major lines of response to this risk in the news recently. I don’t find either one convincing.
Regulation
The first is that the UK banks (especially the bigger banks) have faced tougher regulations since 2008 and these will prevent them from failing. I think this is clearly mistaken.
It’s true that the banking sector is more carefully regulated than it was. But no two crises are the same, and SVB Financial in the US didn’t fail because its assets went bad – it failed because it didn’t have enough liquidity.
Basel III imposes liquidity requirements on UK banks that cover a certain amount of stress. But I think a full-blown banking panic might well take the pressure beyond this.
That’s why I don’t see that the regulations designed to prevent a repeat of the 2008 crisis have any relevance to the current situation. The threat to the banking sector at the moment comes from liquidity, not loans going bad.
Importance
The other response I’ve heard is that the big banks on both sides of the Atlantic are extremely important. So the central banks and/or governments in each case will have no choice but to shore them up if necessary.
I think this is probably true, but I don’t think that’s any use to shareholders. The example of SVB financial seems to bear this out.
In the US, customers who had deposits with SVB have – to some extent – been protected. But as far as I can see, the bank’s shareholders haven’t been bailed out in any way.
The fact that authorities might have to protect bank customers doesn’t entail that the banks themselves – or their shareholders – will receive any kind of support. So I don’t think this line of response is any good, either.
Risks and rewards
I think a lot of investors are taking the view that the UK banks – especially the biggest and most important ones – simply can’t fail. And I think they’re dead wrong.
In my view, the entire issue comes down to one thing and one thing alone. Are the customers of the UK banks about to demand their deposits in a way that causes a liquidity crisis?
If they are, then I think the banks and their shareholders are in big trouble. If they aren’t, then this is a terrific opportunity to buy shares in UK banks.
I’m of the view that they aren’t. The US bank failures came from tech start-ups needing their deposits back and UK banks have much less exposure to these businesses.
I think that shares in UK banks are a bargain right now. But the risks are serious and I’m taking them extremely seriously.
