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Could British bank shares be about to plummet?

Hand flipping wooden cubes for change wording" Panic " to " Calm".

Investing is often about hard, cold facts. But emotions can play a role too. That leads some investors to make expensive mistakes, while others benefit from opportunities as a result. Bank shares in the US fell sharply at the end of last week as news emerged of the second largest bank failure in the country’s history. In a classic bank run, depositors scrambled to withdraw funds.

Could that negatively impact shares on this side of the pond this week and beyond?

Nervous market

I think it definitely could.

When one bank fails, there is usually concern about systemic risk elsewhere in the economy. It can be that one bank is simply the first to go and other institutions with similar risk profiles are also permanently shuttered. Indeed, over the weekend another US-based bank was closed down by regulators.

But there are other systemic risks. Companies might be unable to pay bills because their accounts are with a bank that has closed. Credit can be squeezed immediately, with knock-on effects in the financial sector but also across the wider economy.

That amounts to a lot of uncertainty. Markets hate uncertainty. If investors start to dump bank shares, that could see prices move down sharply, even if no further banks collapse.

So far the failure is limited to specialist US banks with sizeable exposure to the tech sector. That is very different to the business of mainstream UK lenders like NatWest and Lloyds. Nonetheless, bank failures inevitably hurt investor confidence. I expect that to dampen enthusiasm for financial shares this week and beyond on both sides of the Atlantic.

Potential buying opportunity

Famous investor Warren Buffett says to be fearful when others are greedy and greedy when others are fearful.

There will be lots of fear on Wall Street and in the City in coming days. Investors are trying to gauge whether we are looking at a situation involving just a couple of banks, or a potentially more widespread event.

That could lead to bank shares falling sharply. In many cases, though, the banks themselves may be in good condition and suffer limited or no impact from wider events. So any widespread correction in bank shares might let me grab some real bargains for my portfolio by purchasing shares in excellent businesses that have seen their prices fall while the underlying performances remain strong.

Why I’m shunning bank shares

However, I have no plans to buy bank shares soon.

Although the potential reward is appealing, assessing the risks involved is way beyond my capability as a private investor.

As we saw in the financial crisis, it can be very difficult to know what exposure any particular bank has to risks arising from the failure of another financial institution. Lloyds shares have moved up 3% in the past year but are still worth over 80% less than they were going into that financial crisis.

One reason I have sold all my bank shares over the past year is because I am concerned at the risk of higher defaults in a weak economy.

The latest news from the US is a reminder of other potential risks lurking in this area. For now, I remain wary of the risks in the sector and have no plans to buy any bank shares.

The post Could British bank shares be about to plummet? appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.