Should You Invest in Bank Stocks While Some Banks Are Failing?
In the midst of economic uncertainty created by high inflation, rising interest rates and talk of a recession, bank stocks got a one-two punch in the form of the collapse of two high-profile banks — Silicon Valley Bank and Signature Bank of New York. Unlike the failures of some smaller regional banks, these two companies were previously well-respected banks with popular stocks.
So what exactly does the failure of these two big banks mean for you if you’re invested in more mainstream companies like Bank of America or Chase? Read on to learn about what you’re likely to face.
What Exactly Caused the Failure of These Two Banks?
In a nutshell, both Silicon Valley Bank and Signature Bank of New York failed due to a run on the banks. A run on a bank occurs when many depositors try to withdraw their money in a short period of time. As banks mostly loan out depositor money, few have the assets on hand to handle a mass exodus of customers. When they all come calling at the same time, a bank can fail.
Bear in mind that what really triggered the failure of these banks was an announcement by Silicon Valley Bank that it was taking tremendous losses in its investment portfolio. These weren’t “bad investments,” as they were in low-risk Treasury securities, but due to rising interest rates, the bank was forced to liquidate some at a loss, starting its loss of liquidity. The bank run by depositors finally pushed them over the cliff.
Risks of Failure With Major Banks Are Low
When it comes to Bank of America, Chase and other household banking names, the risk of failure is quite low. Silicon Valley was a bit of a unique bank, primarily funding startup companies and accepting large numbers of cash deposits from venture capitalists. Bank of America, Chase and others, however, are extremely well diversified, with operations from checking and savings accounts for mom and pop Americans to construction loans, credit cards, home mortgages and international trade. It’s highly unlikely that any one of those areas will have a complete failure, let alone all at once.
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Something else to remember is that for the most part, the accounts of savers and investors at major banks are insured. The FDIC protects every depositor against failure for up to $250,000 per bank for each “ownership category.” For example, if a client has a savings account in his or her own name, a joint checking account with their spouse and an additional IRA account, each of those carries the $250,000 insurance.
Part of the problem with Silicon Valley Bank is that wealthy investors held more at the bank than was insured, causing them to run in and pull their money out at the first sign of weakness. As this effect cascaded, it caused a failure. But that’s much more unlikely at one of the major banks.
The Government Stands as a Backstop
Even with the failure of Signature Bank and Silicon Valley Bank, the U.S. government stepped in and said that it would make each depositor whole. While you can’t rely on this type of government intervention in the face of failure, it seems likely that the government wouldn’t bail out a number of wealthy entrepreneurs and then let a bank like Chase or B of A fail, taking down middle America with it.
Although under different circumstances, the financial crisis of 2008 showed the same type of resolve from the U.S. government, when it stepped in with a huge bailout to help protect the American economy. This type of backing can help protect an investment in these types of banks.
There Are Still Economic and Financial Risks
Beyond the risk of a true bank failure, which is quite remote, there are definite and specific risks to making an investment in a company like Chase or Bank of America.
A recession, for example, could crash bank profits, which would send the stocks of these types of companies lower. Higher interest rates can ultimately generate more revenue for banks in the form of loan interest, but it also means they have to pay depositors a higher rate as well. If deposits grow but loan interest stalls, this could pinch their margins. Banks also have to deal with a host of regulatory requirements, some of which can hinder their growth.
Bottom Line
As an investor, you shouldn’t fear failure at a major bank like Chase or B of A as much as you should be concerned with real numbers like interest rates, corporate earnings, bank asset size, price/earnings ratios and the growth rate of the economy as a whole. Speak with your financial advisor to help determine if snapping up bank shares matches your investment objectives and risk tolerance.
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