Why I’m Avoiding All Bank Stocks

The big banks continue to benefit at the cost of the small banks.

When the financial crisis hit, big banks received government bailouts, while the smaller banks that did not take part in the mortgage-backed securities scandal received nothing (no “bailout money”) for doing the right thing.

Four years later, big banks continue to reap the benefits of government bailouts. In the meantime, small banks are paying the price for being responsible.

In 1980, there were over 13,000 banks U.S.; but, today, there are roughly 6,600 banks (source: Wall Street Journal, June 19, 2012). Thus far, 2012 is shaping up to be the year of the most bank mergers. In 2002, there were over 4,000 banks with assets of at least $100 million. Today, there are only 2,416 banks with over $100 million in assets.

The reason small banks are selling out to bigger banks or merging is that once the financial crisis hit, even though these small banks held no toxic mortgage-backed securities like the big banks, some of the loans they did have were defaulted upon. This was bound to happen, as the ensuing recession caused businesses and consumers to feel economic distress, which meant they had to default on loans they could no longer pay back.

Because the economic recovery has not taken hold here in the U.S., businesses and consumers are not spending, which means they are not taking on new loans. Since the main business of smaller banks is loans, they have been hurting. In the meantime, big banks are speculating on the markets and have received government bailouts in the form of loans.

The low-interest-rate policy currently in place also works against smaller banks and the big banks alike, as banks cannot earn the money they used to when short-term rates and long-term rates were at more normal levels.

As if this state of affairs weren’t unfair enough, the small banks have been told that even though they have done nothing wrong, they must comply with the capital requirements demanded by global regulatory standard Basel III, just like the big banks.

The Basel Committee was created in response to the financial crisis and the suspicious lending practices of the big banks. The committee was established to prevent future crises and hopefully further government bailouts. The Committee attempts to ensure the big banks have enough “good” capital on their books to offset any potential losses.

Basel III is forcing big banks and now small banks alike to raise their core tier-one capital ratios. This means all banks must have a larger amount of specific capital in place. Many small banks are spending time trying to figure out how to comply with regulations, as opposed to expanding their businesses.

The stock market valuations of the big banks remain low, possibly an indicator that there still may be toxic assets on their balance sheets we do not know about. The upcoming U.S. recession will also be difficult for banks, large and small (see: “The Inevitable U.S. Recession; Part II Starts”). Smaller banks that are run more responsibly are being punished as well, which means that, unless an investor knows which banks will be bought out, it could be a dangerous sector of the market to be in.