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According to Warren Buffett, the first rule of investment is to avoid losing money. The only way to do this is to understand the risks and what could go wrong when finding stocks to buy.
Right now, UK bank shares are trading at really attractive prices. But while I think this could be a great opportunity, it seems to me that the risks involved are real and significant.
risks
First, let’s clarify what the risks are and why investors should take them seriously.
In the short term, the biggest risk UK banks face is that a liquidity crisis causes them to fail. If that happens, it would be a disaster for shareholders.
I recently heard two main lines of response to this risk in the news. I don’t find any convincing.
Regulation
The first is that UK banks (especially the larger banks) have faced stricter regulations since 2008 and these will prevent them from failing. I think this is clearly a mistake.
It is true that the banking sector is more carefully regulated than it was. But no two crises are the same, and SVB Financial in the US failed not because its assets failed, but because it lacked liquidity.
That is why I do not see that the regulations designed to prevent a repeat of the 2008 crisis have any relevance to the current situation. The threat to the banking sector right now comes from liquidity, not bad loans.
Importance
The other answer I’ve heard is that the big banks on both sides of the Atlantic are extremely important. So central banks and/or governments in each case will have no choice but to prop them up if necessary.
I think this is probably true, but I don’t think it’s helpful to shareholders. The example of SVB Financial seems to confirm this.
In the US, clients holding SVB deposits have been protected, to a certain extent. But as far as I can see, the bank’s shareholders have not been bailed out in any way.
The fact that the authorities have to protect the clients of the banks does not imply that the banks themselves, or their shareholders, receive any kind of support. So I don’t think this answer line is a good one either.
risks and rewards
I think many investors are of the opinion that UK banks, especially the largest and most important ones, simply cannot fail. And I think they are completely wrong.
In my opinion, the whole thing boils down to one thing. Are UK bank customers about to demand their deposits in a way that causes a liquidity crisis?
If they are, then I think the banks and their shareholders are in big trouble. If they are not, this is an excellent opportunity to buy shares in UK banks.
I am of the opinion that they are not. US bank failures stemmed from tech startups needing to recoup their deposits and UK banks have far less exposure to these businesses.
I think UK bank shares are a bargain right now. But the risks are serious and I am taking them extremely seriously.
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