A guide to trading UK bank stocks

Interest in the UK banking sector has started to grow again as higher interest rates boost profits in the sector. But are banking stocks really a good bet during periods of economic uncertainty? Find out everything you need to know here.

What are bank stocks?

Bank stocks are the shares of financial institutions that provide a range of personal and commercial services, such as lending money, asset management and holding funds.

Top UK bank stocks

In the UK, the top bank stocks can all be found on the FTSE 100 (UK 100) index. Four banking stocks are frequently used as a barometer of the industry’s health in the UK – commonly known as the ‘big four’. These are:

1. HSBC - £115.6 billion
2. Lloyds - £26.9 billion
3. Barclays - £23.1 billion
4. NatWest - £20.8 billion

HSBC

HSBC is the largest UK bank by quite a long way, the second largest European bank and sits among the top-performing banking stocks worldwide.

This is largely due to HSBC’s strong performance presence in Asian high-growth markets, which now account for nearly half of the group’s earnings. Although it’s the largest UK bank, it has relatively little UK exposure.

While the company’s operation in Asian markets is appealing to investors looking to diversify their holdings, it also comes with different risks to be aware of. For example, HSBC is facing concerns over its exposure to the Chinese commercial real estate market, which is expected to slow the economy.

Lloyds

Unlike the other banking stocks on the list, Lloyds is very much still a UK-centric institution. Although it does have an international business, alongside commercial banking and investments, it’s still the high street retail banking division that makes Lloyds the largest amount of income.

While this is great for investors looking for UK exposure and less international risk, the higher dependency on the British economy and lack of diversification can also be seen as a negative – especially as the country deals with the consequences of Brexit and the cost-of-living crisis.

Barclays

UK-based Barclays is a global provider of retail, corporate and investment banking services. Its primary listing is on the London Stock Exchange but has a secondary listing on the New York Stock Exchange.

It’s estimated that two-thirds of Barclays’ profits come from its overseas services, while half is from investment banking activities rather than retail offerings.

The presence of an international business makes Barclays a more popular choice among anyone looking to diversify their holdings, as it’s not solely reliant on the UK market.

NatWest

NatWest might be the smallest of the ‘big four’ UK banks, but it’s one of the largest mortgage providers in the UK. It generates most of its profits from the interest margin it earns between deposits and lending.

Alongside its primary NatWest business, the company also offers banking services through the brands Royal Bank of Scotland (RBS), Ulster Bank and Coutts.

Like Lloyds, NatWest makes the majority of its revenue from its UK business, but it also earns income from Europe, US and Rest of the World revenue streams.

Are bank stocks a good investment?

Bank stocks are typically considered good investments for those looking to make additional capital through dividend payments or diversify their portfolio. However, they are considered ‘middle risk’ stocks given their sensitivity to  an – when rates are high, banks make more money on their loans, when rates are low, it hurts bank profits.

In the UK, after over a decade of low interest rates, banks finally started to see the benefits of an increase in deposits and the ability to generate more income on their loan repayments. This is why interest in investing in the UK banking sector has picked up again, although some investors are still wary due to lingering concerns over a repeat of the 2008 banking crisis.

During 2023, the global banking sector was hit by the collapse of Silicon Valley Bank in the US and the government rescue of Credit Suisse in Europe. Although both ended up being contained, the fear of contagion – like we saw in the 2008 banking crisis – hit banking stock valuations across the globe.

Although banking crises can happen, the industry is still a popular diversification opportunity because it’s one of the largest sectors and provides a huge range of essential services to consumers.

How to analyse bank stocks

As with any company share, there are two main ways to analyse a bank stock:

1. Technical analysis – involves the use of charts and statistics to analyse the direction of a bank’s share price. Traders who use it will look to identify potential entry and exit points based on changes in price, volume, momentum and implied volatility
2. Fundamental analysis – involves looking at what a bank’s intrinsic value is based on publicly available financial statements, and assessing whether its share price is trading higher or lower than that value

How to value a bank stock

Common ways of analysing the value of a bank stock are the:

• Efficiency ratio – This is calculated as expenses (excluding interest) divided by total revenue. It tells investors how well a bank is using its assets as a means of generating revenue. The lower the ratio, the better run a bank is – below 50% is ideal
• Price-to-earnings (P/E) ratio: This is calculated by dividing the market price of the bank’s shares by earnings per share (EPS). Banks that have high expected growth rates and low-risk profiles, tend to have higher P/E ratios than other companies in the industry
• Price-to-book (P/B) ratio: This is calculated by dividing the market price of a bank stock by the book value per share. P/B ratios are also higher among banks that show higher earnings growth, greater return-on-equity (ROE) and lower-risk profiles
• Loan-to-deposit ratio (LDR) – This is calculated by comparing a bank’s total loans to its deposits over the same period. The resulting percentage would indicate the bank’s liquidity levels. If the ratio is high, it means it doesn’t have enough liquidity to cover future requirements, but if it’s too low, the bank might not be earning as much capital as it could be
• Capital-adequacy ratio (CAR): This is calculated by dividing a bank’s capital by its risk-weighted assets. The ratio tells us how well a bank is likely able to operate and meet its obligations amid unexpected increases in loans. It’s used by regulators to assess whether a bank is likely to fail

Given the nature of the business, analysing banking stocks requires a different tact from traders. For example, banks come with different debt levels as fundamentally loan-based businesses. This means that some of the common financial ratios won’t work for bank stocks.

So, it’s important to understand the different risk profiles of each area of banking, to better understand what is concerning about a bank’s balance sheet, and what is part of the business they’re in.

Whenever you’re analysing stocks using financial ratios, it’s important to note that you have to compare companies with similar characteristics that function in similar areas of the industry. For example, comparing a high-street savings and loan bank to an investment firm or broker would provide little useable insight given they have completely different target audiences and aims.

What moves bank stocks?

Broadly, the factors that move a bank’s share price are the same as any other company, including:

• Overall market sentiment
• Macroeconomic health
• Fundamental valuation
• Demand for services
• Expectations of future growth

But for banks, a few other factors come into play, such as:

• Interest rate risk – most of a bank’s assets and liabilities are highly sensitive to any changes in interest rates, so large or unexpected shifts in rates can impact the businesses’ ability to meet obligations or earn a profit, which can impact the value of its shares
• Counterparty risk – a bank is only as trustworthy as the debtors it uses. If there’s the possibility that a party will default on their loan, the bank will be at risk as the underwriter. When consumers or businesses go at risk of default, it can lead to a banking crisis 
• Regulatory risk – bank share prices are sensitive to even the suggestion that a government will create new regulations or loosen existing policies

Banking stocks FAQs

Are bank stocks cyclical stocks?

Bank stocks are considered cyclical stocks because the demand for their services fluctuates depending on the broader economic cycle. For example, during periods of high growth, consumers spend more which increases the use of loans from banks. Conversely, when there’s a recession the opposite is true.  

Are bank stocks defensive stocks?

No, bank stocks are not traditionally considered defensive stocks because their business doesn’t experience consistent demand regardless of the state of the economy. However, investors have historically seen bank stocks as good long-term investments given their history of growth and dividend payments.

Are higher interest rates good for bank stocks?

Yes, higher interest rates are good for bank stocks. Banks make most of their revenue on the difference between the value of the deposits they take in and the value of loans they give out. When interest rates fall, bank profits shrink as the margins are lowered.

Are bank stocks recession-proof?

No, if anything, bank stocks are recession-prone stocks. They are highly sensitive to the state of the economy, which means that if a recession happens, banks' profits are hit. That’s because fewer people need loans for spending, or use their credit cards during a recession.