#1 Sectors in Brief - Why I don't invest in the banking sector

Banking

The banking sector is the group of organizations dedicated to provide services to safeguard customer assets and provide credit for individuals. Banks make profit by charging fees on the services they provide, managing assets and interests.

Commercial banks are that ones which profit mainly comes from interests. In order to make that profit the operation usually involves lending money long-term at high interest rate while getting shot-term deposites to use as reserves to back-up the lendings.

This process involves banks taking the task of managing long term risks, difficult to forecast while being subjected to short term “surprises”, such as Covid-19 or the 9/11.

Investment banks make most of their money from fees from the services they provide to their customers. They also use part of their assets to trade different types of securities.

However, their incentives are focused on making the most amount of money in the shortest period of time, making them susceptible to take part on market bubbles. Hence they tend to operate on a ay that they take risks on complex opaque products and operations. Complex because not all investment bankers involved understand the financial intrument they are trading and its risks - e.g. the subprime mortgages - and opaque because if an investment bank finds the goose that lays the golden eggs will try to avoid reporting it, letting know to its competitors about it.

Fintech

Shortening for the financial technology industry, is the group of companies which provide automation of financial services to banks and payment companies. So much focus has been placed on them lately due to their disruption potential to traditional banks.

However, many of them rely on the banking system infrastructure. See PayPal or Wise for example, if I wanted to bypass my bank a load my account on any of these services with cash I could not.

A common path for fintech companies is starting as a potential disruptor of the traditional banks to end-up providing a more efficient/fast/user friendly solution than traditional banks. Therefore, it’s usual traditional banks partner together with fintech companies.

How I see it

So how does what I have previuosly exposed influences my my decision on not investing in this sector. My decision is taken based mainly in two facts:

1. No competitive advantages

   IMO banks do not offer a differentiate value proposition. Customers choose their banks based on the return they offer and the fees they are subjected to. However, the main factor towards choosing a bank will be its reputation or brand power. People place the largest portion of their savings on institutions with good reputation and solvent.

   The question is, how strong are banks reputations? The banking sector is one of the few that everybody is customer of, being continuosly under the public eye. Hence, some bad news might be amplified on a way that in few months the reputation build thorugh decades might evaporate. One example would be what happened to First Republic Bank back in May 2023.

   FRB had large amount of wealthy customers with deposits over 250000$, threshold which was insured by the Federal Reserve. Bankruptcy of Silicon Valley Bank and Signature Bank back in March 2023 made FRB customers lost confidence on getting their deposits over the non secured threshold what provoked massive amount of funds withdrawed by banks customers.

   Another similar example was Credit Suisse collapse.

2. Out of my circle of competences

   One of the capabilities of commercial banks is the possibility of increaseing short term liquidity of the financial system by issuing credit. This capability its limited by central banks as they establish the monetary policy based on economic data. This means banks activities are limited by the economic cycle.

   Mastering the market cycle can also be difficult for banks. For example, sudden raise of interest rates might compromise their solvency. That was the case of Silicon Valley Bank (SVB), which filled bankruptcy back in March 2023. SVB was too exposed to investment in tech companies while money cost was low.

   Furthermore, investment banks carry complex opaque operations, difficult to risk assess. Large exposure to risky operations can lead even to giants bakruptcy, as it happend with Lehman Brothers back in 2008 during subprime crisis.

   All this operations banks performed are not easy to understand for me, specially considering they are not always clearly reported on 10-k and 10-q. Therefore, I will not use my time on such an poor cost-effective way.

   

   Employees leaving Lehman Brothers the day of the bakruptcy in 2008.

   3. Cyclicality

      If their revenue comes from credit and services fees they will be larger during economic boom periods and lower during recessions.

   4. Regulatory risks

      The industry depends on the central banks decisions. Moroever, the sector impacts the whole population so it is always on the public eye, increasing the risk of regulatory changes impacting it due to political decisions.