Why Not Bank Stocks?

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Warren Buffett, who has a long history of investing in and expressing faith in the banking industry, has recently soured on bank stocks.

Berkshire outright sold Wells Fargo (WFC), JPMorgan Chase (JPM), and Goldman Sachs Group (GS) in 2020 and 2021, while reducing a longstanding holding in U.S. Bancorp (USB) in 2022.

When asked why, Buffett told CNBC simply: “I didn’t like the banking business as well as I did before.”

To better understand why banks make poor investments, we can turn to Terry Smith’s 2023 article following the Silicon Valley Bank (SVB) collapse.

Smith, Chief Executive of Fundsmith and former top-ranking bank analyst from 1984-89, knows banks intimately—and what's surprising is that it's precisely this deep understanding that leads him to refuse owning their shares.

Smith identifies three structural problems that make banks fundamentally different from normal businesses:

These aren't minor issues that better management can fix. They're inherent flaws in the banking model itself, which should become clear by the end of this post.

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Smith never invests in anything that requires leverage to make an adequate return.

Banks have a very small amount of equity to support their balance sheet, and equity is important because it's the only cushion protecting depositors and creditors when loans go bad.

Smith provides NatWest Group's 2022 balance sheet as an example:

NatWest has just £5 of shareholder equity supporting every £100 of assets, a leverage ratio of 20 times. This means if just 10% of their loans go bad (10% of £100 = £10, which exceeds the £5 equity buffer), shareholders are completely wiped out.

Long before reaching that point, depositors typically panic and trigger a bank run, as happened with SVB.

Another event was the 1982 Latin American debt crisis, where Nassim Taleb observed in "The Black Swan" that major American banks lost all their cumulative past earnings.

The point here is that these catastrophic losses aren't rare anomalies but recurring features of banking.

For context, Smith found the average S&P 500 company (including banks) has $26B of assets and $8.5B of equity, meaning they operate with leverage of about 2 times (the remaining $17.5B in assets is funded by debt, giving a debt-to-equity (D/E) ratio of $17.5B/$8.5B ≈ 2x).

Their assets would need to fall by one-third (a 33% decline from $26B to $17.4B would eliminate the $8.5B equity cushion) to eliminate equity value.

Despite taking massive leverage risk, banks generate mediocre returns.

Over the five years Smith analyzed (~2017-2022), the S&P Banks Sector averaged just a 10.9% return on equity (ROE), compared to 17.9% for Consumer Staples companies that operate with minimal leverage.

This poor fundamental performance translates directly to share prices. Banks delivered -15.1% annual returns over the five-year period, while Consumer Staples returned +12.1% annually.

We decided to investigate this performance further, so we plotted total returns from 2010 through 2025 for the SPDR S&P Bank ETF (KBE) against other stable, income-focused sectors:

We chose these comparisons deliberately:

These three sectors—consumer staples, utilities, and REITs—are typically viewed as defensive, income-oriented investments that sacrifice growth for stability.

Yet every single one outperformed banks over this 15-year period. The S&P 500 nearly tripled banks' returns (690% vs 262%), while even utilities, perhaps the most regulated and capital-intensive sector in the market, returned 387% compared to banks' 262%.

As Smith puts it: "So much for the theory that you need to take more risk to get higher returns."

Even well-managed banks face destruction from sector-wide panics.

Smith shares an illustrative anecdote from 1980s Hong Kong during doubts about the territory's future with China's looming takeover:

The takeaway is that banks, unlike most other industries, can be brought down by the actions of their peers. When confidence evaporates in one institution, it can instantly spread to others, regardless of their individual health.

This systemic risk means investors can do everything right (pick a conservative bank with good management and clean loans) and still lose everything when panic spreads through the sector.

Beyond these traditional risks, Smith identifies a new threat: fintech companies steadily replacing core banking functions.

Banks essentially do three things: take deposits, make loans, and process payments. Each function now faces disruption:

Legacy banks struggle with outdated technology systems while new entrants build from scratch without these burdens.

Meanwhile, fintech startups have benefited from years of cheap capital and venture funding that prioritized growth over profitability, allowing them to undercut traditional pricing.

Smith concludes by quoting Paul Volcker, former Federal Reserve Chairman:

The combination of high leverage, poor returns, systemic risk, and technological disruption makes bank stocks uninvestable for risk-conscious investors.

To generate acceptable returns, banks must take leverage that threatens their existence during any crisis. Yet even with this leverage, they deliver inferior returns compared to stable, low-leverage businesses.

Add in the risk that problems at other banks can destroy your investment regardless of individual bank quality, and the proposition becomes even worse.

Therefore, for investors seeking financial sector exposure, we suggest looking elsewhere—namely fintech companies, payment processors, exchanges, or asset managers that participate in financial services without the fatal flaws of traditional banking.