How to play banking sector woes

Banks are back on the slide after being dragged back into the regulatory spotlight. But that give spreads betters several opportunities for profit, says Tim Bennett.

Aside from the satisfaction of collecting an obscene payout the pay packets of bank CEOs leapt 36% last year according to the FT's Jim Pickard it can't be much fun being a banker. Leaving aside the tedium of much of their work, and the low esteem in which they are held by most of us since the credit crunch, they are under attack again here from the coalition government. And that's not the only reason to be bearish on the sector as a spread better.

The latest salvo from the government comes in the form of a proposal that banks should 'ring-fence' their retail activities from everything else. The idea is that the relatively low risk, 'important' bits of what a bank does such as taking savings deposits and making loans should be protected from the activities of the riskier investment banking arms of the same organisations. And whilst much of the detail is yet to emerge, one thing is clear the banks don't like the idea very much.

There have been some ominous threats of free current accounts being scrapped, as the price consumers will pay for the extra cost of implementing the ring fencing. Whether true or not it's clear that the banks are on the back foot and likely to remain in the regulatory spotlight for some time. And that's not good news for share prices most of the big players lost 1% or more when the latest news broke.

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That aside, as Merryn Somerset Webb notes in her recent article there are plenty of other reasons to be wary of bank shares. These include the fact the Bank of England base rate will have to rise soon to combat inflation. That will end a period of next to zero funding costs for our biggest banks. Then there's the "tail risk in bank portfolios" in short the fact many are sitting on more problematic loans than they have admitted to so far. And of course let's not forget the Warren Buffett rule that you shouldn't buy something you don't understand. Can anyone claim to really know how truly profitable these taxpayer-underpinned behemoths actually are?

For a spread better the sector presents several opportunities. You can short individual bank shares or play the sector as a whole against either the wider index or another stronger sector. Just make sure you stick some stop loss orders in to keep your trading risk under control.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.