To me, the Second Axiom of Investing will ALWAYS be Margin of Safety as professor Graham emphasised and as you also touch upon in this essay. It is very difficult to arrive at a safe valuation for a bank/lender incorporating the many risks and hence most value investors look elsewhere, where it is easier to determine a safe valuation range incorporating significant Margin of Safety.

Banks and financial institutions are commodity businesses with creative accounting throw in. Morris Shapiro said some sixty years ago that there are more banks than bankers in the world. Then, most banks used to trade on OTC at 10x earnings and 1x book value.

Given their importance to the economy, they are never allowed to fail and get bailed out. This creates a moral hazard as banks only emphasis growth in business and earnings but cry for help in a downturn.

In Every crisis there is a villain -for eg., corporate loans made during 2008-13 , in India. Hence lenders prioritise retail loans as being safer in the next cycle.. However, given high competition, increasingly retail loans are justified despite their quality...this sows the seed for the next crisis.

A big weakness of fractional banking is that they are safe as long as they are perceived safe. Social media and technology has amplified the risks of panics and bank runs spread much faster now.

A key asymmetry is that if a large retailing business fails, then the competitors can gain market share whereas if a large bank fails, the close peers also start looking vulnerable.

Given all this, it is difficult to find a strong bank at a valuation incorporating the myriad risks. Hence, Caveat Emptor.

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As usual, brilliantly written Anand.

Second Axiom scope could be expanded from leverage to dicey promoters, government interventions, en all, but is as likely to impact returns as first.

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