Bank stocks are the cornerstones of an investment portfolio for many investors. That’s because people and businesses rely on the banking industry in order to keep the economy running.
But not all bank stocks are created equal, as was evidenced after the recent financial crisis. Between 2008 and 2014, more than 500 U.S. banks were forced to shut their vaults.
To prevent a similar event from happening again, banks with assets of more than $10.0 billion must now undergo a regular stress test. Stress tests are a regulatory tool used, in the U.S., by the Federal Reserve to measure a bank’s ability to withstand a crisis. The more capital a bank has, the less it relies on borrowed money, a source of funding that can evaporate in a crisis.
If the bank’s capital falls below a certain threshold—it fails the test and has to take immediate action to make up the necessary capital. Those that fail the stress test cannot increase their dividend payments or initiate share repurchase programs. Most importantly, banks that fail the stress test are seen as risky investments.
Passing the stress test, on the other hand, bolsters confidence in bank stocks. In fact, bank stocks with solid underlying financials can be some of the best long-term plays.
Some of the strongest bank stocks in the world are outside of the U.S. In North America, Canadian banks dominate, taking positions one through six. The top publicly traded Canadian bank stocks include: The Toronto-Dominion Bank (NYSE/TD), Royal Bank of Canada (NYSE/RY), Bank of Nova Scotia (NYSE/BNS), Bank of Montreal (NYSE/BMO), and Canadian Imperial Bank of Commerce (NYSE/CM).