Investing in Bank Stocks

In the United States, during the 1990's several federally implemented acts contributed to banking deregulation that had begun the previous decade. These Acts essentially gave banks the ability to operate with more freedom and with greater commercial horizons. The new laws allowed banks to operate more freely from state to state and to engage in other banking functions. The result became banks that could provide a multitude of services.

Key U.S. banking institutions

A few major U.S. banks are listed below for illustrative purposes. These are just a few of many U.S. banks, several of which play important roles in various aspects of economics and banking services.

Bank of America (BAC): Bank of America is a very large commercial bank that deals with day to day bank services on a world-wide scale across the United States. This company is a large capitalization bank with share value of 223 Billion dollars and offers a wide array of consumer and commercial banking products.

Meryl Lynch (MER): Meryl Lynch is another large bank that operates primarily in the investment banking sector of the U.S. economy and globally. This bank has a market capitalization of near 61.5 Billion dollars, and its major products and services include brokerage, institutional investing, and financial advising services along with several related banking products and services.

Countrywide Financial Corporation (CFC): Countrywide Financial is yet another very large bank that deals primarily with mortgage lending within the United States. Its market capitalization is near 11 Billion dollars and in 2007 its share prices fell dramatically due to financial turbulence caused by factors relating to a weak housing market.

Benefits of investing in banking stocks

Banking stocks are a unique to the type of services and products they offer. While the stocks may fluctuate significantly in value over the short run, many large and stable banks offer the potential to grow steadily over longer term horizons. A few of the functions that can lead to a banks asset and profit growth are listed below.

• Mergers and Acquisitions: Banks that facilitate, finance and engage in a high volume of corporate mergers and acquisitions have the potential to yield an increase in profit margin due to the increase in return on assets associated with these banking activities.

• Initial Public Offerings: When companies increase in size or become public, they often seek additional financing for expanded operations and project implementation. Banks that facilitate these activities well can benefit from them.

• Credit Services: Banks that engage in credit services have the potential to earn substantial profits dependent on the creditworthiness of their clients and interest rates they are able to charge.

Risks of Investing in Banking Stocks

• Sector Downturns: In the case of the aforementioned banks, an economic downturn in any one of the markets these banks deal in could cause a lot of volatility in the share prices of those companies. As we have seen, the downturn in the United States housing market led to stock volatility in shares of 

Countrywide financial corporation

• Economic adversity: If an economy turns sour, the banks may be the first to feel it as consumers, corporations and institutions run to banks to liquefy their assets, default on loans and redeem their funds. These factors and changes in currency valuation, federal banking policy and profitability can be another risk of investing an banking stocks.

Key metrics of banking institutions

Since there are many types of banks engaging in a variety of services choosing the right financial metrics to assess these companies can be tricky. Nevertheless, the two following measurements indicate a banks essential capital and operational stability.

• Capital Reserve: The amount of unused liquid assets a bank maintains on its balance sheet is an indicator of solvency. Capital reserve amounts in excess of 10% are considered sufficient by U.S. regulatory agencies. An example formula for assessing capital reserve is the capital adequacy ratio (CAR) which divides capital by assets such as loans which are weighted for risk.

• Daily Value at Risk (VAR): A VAR calculation can be used to determine the risk level of its investments and/or banking products using a multiplier for precaution. An example of this calculation takes the potential dollar value loss within a specific time period using the worst 10% of investment assets multiplied by 4. If over 365 days, a bank's worst 10% of loans cost them $20,000.00. Multiplied by four, and divided by 365, their daily value at risk would be $80,000.00//365 or $219.18 of risk per day or $80,000.00/year. Naturally, the higher this value is in comparison to other banks, the greater the measured risk of the banks investments.