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Banks Face Big Challenges

Brexit Banks

Image source: Kurt Pacaud / Shutterstock.com

What's going on?

Amidst further market turmoil on Monday following last week’s Brexit vote, the stock prices of banks continued to get hammered – especially in the UK and Europe.

What does this mean?

People get nervous when bank stocks sell off sharply because banks are fundamental to the normal functioning of an economy. They grease the wheels of capitalism by acting as the conduit through which people and businesses borrow and store money. One big concern is lower interest rates: they have come down because investors have flocked to the perceived safety of government bonds. This pushes the price of government bonds up and interest rates down because the two move inversely (read a full explanation here). Lower interest rates decrease banks’ profits by limiting what they can charge clients to borrow money. The hit to bank stocks has been eye-watering: UK banks like Barclays and RBS have seen about one-third of their values erased in two days (while most US banks are down about 10%).

Why should I care?

For the markets: Watch out for chatter about “CoCo’s. Unfortunately, it’s not hot chocolate. Banks in Europe and the UK have issued a lot of so-called “contingent convertibles” in recent years. They market them as bonds (which are considered safer investments than stocks), but they have a catch: if a certain trigger is hit, then the owner of the “bond” is forcibly given the bank’s stock instead. Since these “bond” investors typically don’t really want to own the stock, they sometimes preemptively sell the stock (a.k.a. “go short”) to offset their potential future ownership – and that puts immediate downward pressure on the stock price. It’s worth keeping an eye on this area.

For you personally: Deposits in banks are insured by the state. In Europe, bank deposits of up to €100,000 are insured by the individual states (e.g. Spain insures deposits at Spanish banks) and in Britain it’s up to £75,000. So, although falling bank stocks are worrying to investors, the government is responsible for protecting depositors. It does, however, show that the health of a country, like Portugal, is tied to the health of its banks (because the state is on the hook if the banks can’t pay back its depositors).

Originally posted as part of the Finimize daily email.

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