Regulators Raise the Ante on Short Selling Amid Banking Turmoil

Highlights

• The regulatory scrutiny on short-selling in the banking sector has intensified.
• The U.S. Department of Justice has shown an interest in probing this activity.
• Short-sellers have been raking in profits since the banking crisis emerged.

Bank stocks have been in turmoil in 2023, and things could get worse before they get better. While regulators have stepped up to salvage several banks this year, they have now shifted their attention to short-selling activity in bank shares leading up to the industry crisis.  

With the failure of Silicon Valley Bank, Signature and First Republic, banking stocks have been extremely volatile of late. Short sellers, who are betting on declines in stocks they find to be overvalued, have come under a microscope after earning $1.2 billion in profits in early May.

Meanwhile, bank stocks demonstrated some resilience last week, placing short-sellers in a squeeze on their risky bets. 

According to reports, the U.S. Department of Justice is probing the possibility of market manipulation in the stock market surrounding banks. This ups the ante to a new level now that criminal prosecutors are involved in addition to the regulatory investigations that were already underway. 

Short selling targets stocks that appear to be overvalued in the market. Experts have defended the practice. Steve Sosnick of Interactive Brokers is quoted by Bloomberg as saying “healthy companies don’t go to zero simply because there is an abundance of short sellers.”

The U.S. SEC also has bank stocks on its radar, with some critics reportedly calling for a bank on short-selling. However, this is unlikely to happen due what would likely be a lack of support among SEC commissioners. 

Banking Stocks in Turmoil 

Since the failure of SVB in March, which set off a domino effect, regional bank stocks have grabbed the spotlight. The KBW Regional Banking Index, a widely watched barometer of this sector, has shaved off nearly 25% of its value since that time.

The banking index was down 1.5% today amid a broader market sell-off on recession fears.