Pros and Cons Of Investing In Banks

When the federal government stepped in to bailout the banking industry in 2008, the reason was because the aid recipients were so important that their collapse would take the country’s economy with them.

The official term used is “too big to fail,” and it’s long been associated with the big banks. Amid the chaos of the novel coronavirus catastrophe, the financial sector’s standing makes it a predicator of deeper economic woes. So, what are the pros and cons of investing in banks?

That’s the question we’re going to answer in this article. We’ll explore the different revenue streams they have, how they’re faring with the provisions of the CARES Act that prevent things like foreclosures, evictions and student loan collections, and which banks are your best bets. 

Is It Smart to Invest In Banks?

Banks are in the business of money. This means they take deposits from customers to establish accounts like checking, savings, certificates of deposit, and more. These funds are then used to fund mortgages and other loans, collateralized or not.

This generates revenue for the businesses, assuming everything works exactly as it should. When people default on loans or otherwise reduce their payments, it chokes the bank’s overhead. This is just one reason some people wonder if it’s a good idea to invest in banks at a time when the country is experiencing economic hardship.

On top of this, banks often find themselves the target of government regulation and fines. Wells Fargo (NYSE:WFC), for example, was hit with a $3 billion fine in February 2020 to settle criminal and civil allegations of fake bank accounts fraudulently opened by employees.

This wasn’t a one-off situation, but rather a corporate culture of corruption. And Wells Fargo isn’t the only bank facing such payments.

Bank of America (NYSE:BAC) paid a $42 million fine in 2018 for failing to disclose stock trades for its clients were being routed to outside firms. It’s a drop in the bucket compared to the over $38 billion it paid to settle charges stemming from its foreclosure abuses alongside Countrywide.

Meanwhile Citigroup (NYSE:C) paid a record $57 million at the close of 2019 to U.K. regulators over inaccurate financial reporting. With these types of fines, it’s only natural to wonder if banks are smart investments, especially in the wake of the COVID-19 crisis.

Are Bank Shares A Good Buy?

Despite the regulatory heat and exposure, banks are often considered a strong investment.

In fact, there are three banks in the Dow Jones: JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), and American Express (NYSE:AXP). This index tracks what are known as blue-chip stocks, because they’re the most valuable chips in poker.

Nearly every company in the financial industry took a financial hit back to pre-2017 levels, leaving them all deeply discounted.

While the price is right, the decision to invest depends entirely on whether you believe the banks will recover from the crisis. They walk a fine line, as collection efforts can easily turn into a PR nightmare with the large number of people in financial distress.

Overdraft fees, interest, and other monies charged to people in financial distress quickly became political issues in the run up to the 2020 election. There are also issues to consider with home sales slowing due to fewer houses on the market.

Still, there’s plenty of reason for investors to feel confident about in the financial industry and the “too big to fail” status attached to the big banks. They were given the green light by the Office of the Comptroller of the Currency to involve themselves in cryptocurrencies like Bitcoin.

When the federal moratorium on debts like student loans and mortgages and a wave of defaults inevitably hits, it’s safe to say the government will once again bail out the banking industry.

That’s a reality we’re likely to face, since the Financial Sector ETF is still down over 20% compared to the S&P 500. Let’s talk about the risks involved in banking investments.

How Investing In Banks Is Risky

We already mentioned one major risk of investing in the banks, which is the constant regulatory scrutiny.

Another problem is how hard it is to decipher financial statements. Because they’re in the business of money, a bank’s financial statements look unlike any other business. For example, there’s no inventory, since the bank’s assets are all financial tools.

The balance sheets also look different, since deposits are liabilities and loans are assets. This is the exact opposite of a normal business and is just one part of the confusion around the banks.

Much of the uncertainty these days revolves around how easily both consumers and businesses bounce back from the economic turmoil caused by the 2020 novel coronavirus pandemic.

Both banks and the U.S. Mint are struggling to keep coins in circulation, leading to a coin shortage in the United States. The CARES Act also included mortgage forbearance provisions, something Wells Fargo is accused of mishandling.

The initial stimulus bill provisions expired at the end of July while Congress and the White House scrambled to enact another.

Still, it’s hard not to notice that these companies were deeply discounted during the COVID-19 crisis, and this leaves an opportunity for those willing to invest the money in hopes of financial security.

What Is the Best Bank to Invest In?

If you’re going to invest in the banking industry, JPMorgan Chase is a good way to do it. The company is the largest bank in the U.S. by market cap, and it’s promising to continue paying dividends through the third quarter.

Under the leadership of CEO Jamie Dimon, the bank had the best performance throughout the 2010s, and it’s likely to repeat this pattern in the 2020s.

The bank already has over $8.3 billion put aside to stave off losses from defaults, which Dimon expects will hit in early 2021, when the effects of record unemployment really shows. Because its prices are so heavily discounted and the company has a clear path forward, it’s a solid investment for its industry.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.