How Banks Are Affected by the Stock Market

Hello hello hello, it’s been two weeks since I last posted something. But well I’m glad I have finally. Many of my followers actually kept on asking me what impact does the stock market have on Banks around the world.

To begin with, Banks have always been affected by the stock market from way back. The Great Depression began with a stock market collapse. However, it is now widely held that what turned a stock market dive into the worst depression in U.S. history was the ensuing collapse of U.S. banks and the resulting contraction of the money supply. There are historic reasons for the perceptiveness of the banking industry to the stock market, but in the 21st century new credit markets and new ways of leveraging capital increase that perceptiveness.

Retail Banks and Lending

Bank stocks loosely correlate with consumer cyclicals; stocks of companies that outperform the market in good times and under-perform in bad times. In a soaring stock market, economic activity increases. Consumers and businesses borrow money for capital investment and consumer purchases. When the stock market falls, automatically businesses and consumers lose confidence, and economic activity slows down. Businesses and consumers borrow less too. As the economy contracts, fewer customers qualify for loans. Banks are often hit again in this downturn, when many consumers can no longer pay their mortgages.

Investment Offerings

Retail banks almost on a daily increasingly offer their customers investment services. Merrill Lynch, for many years one of Wall Street’s larger brokerage and investment houses, is now an integral part of the Bank of America as an American example. When the stock market falls, investment activity slows down and retail banks with brokerage functions are antagonistically affected. In a rising market, the reverse is true.

Recovery Hazards

Falling stock markets are clearly hazardous for banks like Equity Bank, Bank of Africa, Housing Finance Bank and ABSA relating to East Africa, but in some circumstances the economic and political initiatives promoting economic recovery can also pose problems. In a thoughtful 2013 Forbes article, Jerry Bowyer demonstrates that various government activities designed to keep interest rates low to stimulate economic recovery initially cause the stock market to rise, but ultimately weaken the recovery and contribute to rising interest rates. Both predicaments are generally bad for banking. Bowyer likens what happens to a beach ball resting on water. The farther down you push the ball, the higher it rises when you remove your hands. In 2013, for instance, hints that the Fed’s low interest rate policies might soon come to an end sent the stock market into a series of momentary dives, accompanied by significant rises in bond rates.

Investment Banking

In the 21st century, investment banks like Goldman Sachs and Lehman Brothers bought and sold highly-leveraged sub-prime real estate debt instruments that generated enormous profits until 2008, when a real estate boom collapsed and they generated even larger losses. The failure quickly spread to the stock market and then to the greater economy. Banks suffered at every stage of this collapse. Many, like Lehman, went bankrupt, and others struggled to survive.