Investing in banks is like playing financial Russian roulette

The Bank of England’s (BoE) mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability.

The central bank of the UK sees great risk to the people of Britain from the nation’s big banks. That much is clear from a press release issued this week regarding a proposed timetable for bank stress testing.  

A veiled warning?

The tests are set to become more comprehensive because the Old Lady of Threadneedle Street sees a wide range of potential threats to the businesses of Britain’s big banks. I reckon investors should heed this veiled warning as any one of these risks could send profits and share prices plunging — perhaps permanently — at big banks such as Lloyds Banking Group (LSE: LLOY). 

Investing in banks now is like playing financial Russian Roulette with your savings, I reckon. You never know when the chamber is loaded. The potential financial carnage resulting from a ‘hit’ with one of the risks to banks is too great a price to pay for any upside that may materialise from an investment in them.

The BoE’s press release sets out the timetable for publishing the UK stress test results for 2016 and announces the firms that will take part in what the central bank calls its 2017 biennial exploratory scenario.

Cyclical risk

The 2016 stress test aims to assess the resilience of the UK banking system to a severe slowdown in the UK and global economies. In other words, risks associated with the natural rollout of the financial cycle. The BoE is analysing the results of initial stress test submissions received from Barclays, HSBC Holdings, Lloyds Banking Group, Nationwide Building Society, The Royal Bank of Scotland Group, Santander UK and Standard Chartered, and aims to publish the results alongside its Financial Stability Report on 30 November.

The BoE explains that the 2016 stress test assesses the resilience of the UK banking system to a severe slowdown in the domestic and global economies by applying a ‘tail risk’ scenario designed to be severe and broad enough to assess the ability of UK banks to withstand a severe shock. Not a forecast, the BoE insists, just a ‘what if’. However, for 2017 the tests will go much further than appraising the banks’ abilities to withstand mere cyclical shocks.

Testing resilience against wider threats

Next year the stress test of major banks will for the first time include two scenarios, the BoE says. In addition to the annual cyclical one, there will be an additional ‘exploratory’ scenario, which will allow the BoE  to assess banks’ resilience to a wider range of potential threats. Potential threats that are real and probable, I would argue. The longer investors hold on to their banking shares at this mature stage in their recovery from the financial crisis, the more likely they are to be hit by the manifestation of one of the risks — just like pointing a loaded gun at your head in a game of Russian Roulette.