A Guide to Investing in Regional Bank ETFs

Regional bank ETFs gained national attention in the immediate aftermath of the regional banking crisis of 2023. For investors considering an investment in this niche banking area, now is a good time to consider the pros and cons of investing in ETFs that invest in regional bank stocks. 

What Is a Regional Bank ETF? 

A regional bank ETF is an exchange-traded fund that aims to track the performance of an index composed of regional bank stocks. Regional banks are financial institutions that operate within a specific geographic region, often serving local communities and smaller markets compared to national banks.  

Therefore, a regional bank ETF provides investors with a way to gain low-cost, diversified exposure to a portfolio of regional bank stocks without having to individually select and purchase these stocks. 

The Largest Regional Bank ETFs by Total Assets 

The largest regional bank ETFs, as measured by assets under management through August 7, 2023, are: 

• SPDR S&P Regional Banking ETF (KRE) 
• iShares U.S. Regional Banks ETF (IAT) 
• Direxion Daily Regional Banks Bull 3X Shares (DPST) 
• Invesco KBW Regional Banking ETF (KBWR) 

The Regional Banking Crisis and ETFs 

The regional banking crisis of 2023 led to the failure of a number of banks, most notably Silicon Valley Bank (SVB) and First Republic Bank (FRCB). Regional bank ETFs took a significant hit after the crisis. For example, the SPDR S&P Regional Banking ETF (KRE) fell by more than 30% in the weeks following the collapse of SVB.  

The decline in regional bank ETFs was also part of a broader sell-off in the stock market. Investors were worried about the global economy and the potential for a recession, which led to selling pressure across all asset classes. 

However, once the crisis appeared contained, KRE and other regional bank ETFs significantly recovered. From its postcrisis low on May 4, through its recent high on August 7, 2023, KRE was up more than 35%. However, the ETF was still below its precrisis levels. 

New Regional Bank Regulations Could Affect ETF Performance 

New regional bank regulations could potentially affect the future performance of regional bank ETFs in a number of ways. 

• Increased capital requirements: New regulations could increase the capital requirements for regional banks. This could make it more difficult for regional banks to raise capital, which could lead to lower profits and lower stock prices for regional bank ETFs. 
• Changes to lending practices: New regulations could also change the way that regional banks lend money. This could lead to changes in the types of loans that regional banks make, which could affect the risk profile of regional bank ETFs. 
• Increased compliance costs: New regulations could also increase the compliance costs for regional banks. This could lead to lower profits and lower stock prices for regional bank ETFs. 

However, it’s also possible that new regional bank regulations could have a positive impact on the future performance of regional bank ETFs. For example, new regulations could reduce the risk of bank failures, which could make regional bank ETFs more attractive to investors. 

The Pros & Cons of Investing in Regional Bank ETFs 

Regional bank ETFs provide investors with many potential benefits, including potential for growth. However, investors should also consider the associated risks, including interest rate risk and regulatory risk. 

Here are some of the pros and cons of investing in regional bank ETFs: 

Pros 

• Potential for growth: Regional banks can be a good investment if you believe that the economy is going to grow. This is because regional banks tend to do well when the economy is growing, as they are able to lend more money and earn more profits.  
• Diversification: Regional bank ETFs offer diversification by investing in a basket of regional banks. This can help to reduce risk, as it is less likely that all of the banks in the ETF will experience problems at the same time. 
• Liquidity: Regional bank ETFs are typically very liquid, which means that they can be easily bought and sold. This can be important for investors who need to access their money quickly. 
• Low fees: Regional bank ETFs typically have low fees compared to actively managed funds, which can help to boost returns. 

Cons 

• Interest rate risk: Regional bank ETFs are exposed to interest rate risk, which is the risk that the value of the ETF will decline if interest rates rise. This is because higher interest rates increase the cost of borrowing and can place strain on smaller banks’ ability to lend. 
• Credit risk: Regional bank ETFs are also exposed to credit risk, which is the risk that a borrower will default on a loan. This can lead to losses for the ETF if the borrower defaults on a large loan. 
• Liquidity risk: Regional bank ETFs can be illiquid in times of market stress. This means that it may be difficult to sell your shares at a fair price. 
• Regulation risk: Regional bank ETFs are exposed to regulatory risk, which is the risk that new regulations will be implemented that negatively impact the performance of the ETF. 

Is It Time to Invest in Regional Bank ETFs? 

Regional bank ETFs have significant growth potential; however, they may face more downside pressure in the short term, especially if the economy weakens and inflation remains elevated. Therefore, with a long-term outlook and high tolerance for risk, an investor can enter a new position after understanding the potential for short-term volatility.  

Overall, regional bank ETFs can be a good investment for investors who are looking for diversification, liquidity and low fees. However, it’s important to understand the risks involved before investing in any ETF.