November 3, 2015

The Impact of Stocks on the Banking Industry and the Loan Market

Stock market activity has a big influence on the banking industry, and vice versa.

The stock market has long had an effect on the banking industry. The biggest and most obvious example would be the Great Depression, which started after the stock market collapsed.

But the reasons for the banking industry's sensitivity to the stock market have evolved, with innovative means of swaying capital heightening this sensitivity.

Stock Market Effects on the Banking Industry - It Can Go Both Ways

Recent stock market activities have both pushed the banking industry up, and driven it down. Just recently the wealth management business of Bank of America Corp dropped 19 percent in 3Q, highlighting how a plethora of stock market selloffs can happen even in areas that banks may consider to be highly stable. The bank's wealth and investment management unit's income plunged to $656 million in the third quarter from $812 million from the same time last year.

With the US stock market plummeting throughout the quarter, many investors shied away from trading, thereby slashing the brokerage unit's commission revenues. Commission income also suffered as a result of a reduced number of initial public offerings and sales of mutual funds.

Banking activity tends to shrink as a direct result of reduced stock market activity.

More recent stock market activity can also illustrate the effect of stock market activity on the banking industry. As of October 20, the banking industry is sitting up at 0.4 percent versus the S&P 500. Three stocks in particular have been touted with helping to push the banking industry up: PNC Financial Services Group (PNC), U.S. Bancorp (USB), and Wells Fargo (WFC). All of these financial companies traded up on that trading day, subsequently hoisting the banking industry.

The opposite effect is also true, however. On the same trading day, three other poorer-performing stocks pulled the banking industry down: Banco Santander Brasil SA/Brazil (BSBR), Lloyds Banking Group (LYG), and ING Groep N.V (ING), all of which traded down and effectively drove the banking industry down along with them.

Stock Market Activity Touches Various Aspects of the Banking Industry

In a healthy, rising stock market, economic activity increases. Businesses and consumers are more confident in their spending and are even more apt to borrow money for investments and purchases. On the other hand, when the stock market plunges, borrowing activity among businesses and consumers drops. Banks are typically hit in these market downturns, as during these times many consumers defer borrowing or fall into arrears.

Bank of America has recently been negatively affected by poor stock market activity.

Investment activity also tends to slow down when the stock market falters. Retail banks that offer their customers investment services will feel the brunt in this scenario. The reverse is true in a surging market.

The Banking Industry Also Affects the Stock Market

It's not just a one-way street. The banking industry also has a profound effect on the stock market.

The financial services sector - which houses the banking sub-sector - holds great weight within the S&P 500, making it important to the US equity market. In fact, it is the second-largest sector in this index, behind technology, with 16 percent of the weight of the US stock index allocated to financial services stocks. As such, if the financial services sector lags, it will have a significant overall impact on the S&P 500.

The banking industry also has a significant impact on capital markets. Publicly traded firms depend on access to the capital markets to boost growth, and in turn, strong capital markets can help stimulate growth that other areas of the economy can benefit from. Banks help to provide this accessibility to financial markets. A strong banking sector helps keep risks at bay when it comes to market participants and the broader economy.

The Effect on the Loan Market

Loans are arguably the most important function of banks - this is how investors can determine the health of the broader market and economy. For instance, if banks are not making as many loans on a yearly basis, this could be a sign that bankers are worried about the short-term outlook of the economy. By the same token, investors who discover that banks are reporting higher reserves set aside to cover defaulted loans would be concerned that consumer and business credit quality is declining.

The US has been submerged in a long-sustained low-interest rate environment, one which negatively impacts the performance of the US banking sector. While interest rates that banks earn from loans have dropped, borrowing costs can't fall below zero. This means that banks are incapable of using many deposit-pricing strategies to improve their margins. The value of lower-cost deposits has therefore plummeted, resulting in lower margins for the majority of US banks.

The Bottom Line

Despite the pull that the stock market has on the banking industry, there are still many measures that can be adopted in an effort to weather any stormy conditions that the stock market may experience, which directly affects banks. And one of the best ways to ensure your financial institution's loan portfolio remains strong is to partner with a team of professionals who make it their business to specialize in the realm of loan portfolios.

At Garnet Capital, this is what we do. It's all we do.

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