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Why trading assets are an important indicator for banks

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What are trading assets?

As we discussed in the previous parts of this series, loans and securities are the most important types of bank assets. Securities are the second most important category of assets. A large part of the securities that a bank holds is for trading. These are known as trading assets, which are mostly in the form of government bonds and notes. Trading assets may also include other types of bonds such as mortgage-backed securities. Banks trade in these securities to earn revenues.

The revenue stream from trading assets is volatile and bad trading calls can result in losses. Such losses do happen in banks. It is important for investors to understand that banks with a higher percentage of trading assets carry more risks.

Trading assets of banks have fallen over the years

The banking sector has shown a trend of decreasing trading assets. This is because after the sub-prime crisis, banks have started to better understand risks in trading assets. Many banks such as Lehman Brothers were completely destroyed due to not understanding the risks associated with this revenue stream.

Total trading assets at banks stood at $655 billion at the end of 2014. Trading assets have increased by 24 basis points since 2Q14. This has largely been due to slow loan growth and expectations of the Federal Reserve raising rates.

Banking sector trading assets stood at 4.22% of total assets at the end of 2014. At the beginning of 2012, this ratio was close to 5.09%. This significant decline of 87 basis points over two years is an indicator of the shift in the fundamental structure of the banking sector. This is true for all big banks such as Wells Fargo (WFC), Bank of America (BAC), JP Morgan (JPM), and US Bank (USB). All these banks are a part of the Financial Select Sector SPDR (XLF). These banks account for 24.52% of the total portfolio weight of XLF.

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