Was buying bank shares my biggest mistake?

Bank stocks have erased gains from the start of the year. This stems from the collapse of one of the largest US banks, Silicon Valley Bank (SVB). This raises fears about other banks and whether they are really safe investments. So, am I wrong to invest in bank stocks?

Lose credibility

Due to the different business models of banks, compared to other companies, investing in these banks can be risky. It is because they operate under influence. In other words, banks use customer deposits to finance assets, such as loans and investments, and earn profits from them.

This is risky because if the asset loses value, and customers demand money, the bank may have to sell the asset at a loss. And if enough of those assets are liquidated, the bank could collapse, as happened to SVB and Signature Bank earlier this month.

So, banking as an industry is only as strong as the trust of its customers. Once gone, banks can plunge very quickly and easily, no matter how strong their fundamentals are.

Thus, it is not surprising to see a new sale of bank shares. Investors fear that the dominos will not stop falling, with bigger banks coming next – and Credit Switzerland‘s recent death has only worsened the sentiment.

High risk, low reward?

There is a view that taking high risks has the potential to yield high rewards. However, this is not always the case, and banks are a prime example. Even in FTSE 100best bank stocks (Lloyds) is nowhere near replicating its success S&P 500 during the past five years.

This is because bank stocks tend to be cyclical in nature, meaning they only do well when certain economic and trading conditions are right.

Lenders tend to do better in developing economies and when interest rates are higher. But with the economy growing slowly and interest rates remaining near zero for the past decade, Lloyds shares have remained flat.

Therefore, if rates remain in the goldilocks zone (2%-3%) over the medium to long term, the bank’s shares can start to rise. This is when interest rates are high enough to generate interest income, and low enough to spur economic growth.

Are bank stocks worth buying?

That said, it does not change the fact that banks are still risky investments. The finances are complex, and the balance sheet may have unrealized losses that are not disclosed. Therefore, it is important to invest in banks with strong liquidity and a low-risk deposit base, such as in the UK.

This is due to the fact that British banks are regulated more strictly. They have a lower number of risk-weighted assets, and more customer deposits are insured, by the Financial Services Compensation Scheme. This means that open banks are less likely to happen.

Although shares of the bank are not always a cup of tea, I recently sold-off has been given the opportunity to buy I can not ignore.

Most valuation multiples are at decade lows, and given the margin of safety, the risk reward proposition is certainly attractive. Therefore, I don’t think investing in bank shares is a mistake – at least not yet – and that’s why I would like to add more to my Lloyds position and buy names like Barclays.