Short selling is a form of investment that bets on the decline of a security’s price. Short sellers borrow shares and sell them in the market, hoping to buy them back later at a lower price and pocket the difference.
However, some industry players have accused short sellers of manipulating the market and spreading fear among investors and depositors. The American Banker Association (ABA) wrote to the U.S. Securities and Exchange Commission (SEC) on May 4, expressing concern that some share prices do not reflect the underlying fundamentals of the banks.
JP Morgan echoed this sentiment in a note to its clients, saying that it has never seen a “perfectly healthy bank” end up in the hands of the Federal Deposit Insurance Corporation (FDIC) within a very short period. The FDIC is the agency that takes over failed banks and protects depositors’ money.
The analysts said that even banks in good financial positions have been affected by the pressure from short sellers, as more Americans worry about their money in these banks. They cited examples of Pacific Western in Los Angeles and First Horizon in Tennessee, whose share prices have plummeted in the past two months.
According to data firm Ortex, short sellers have made $1.2 billion by betting against struggling regional banks that hold $532 billion in deposits. Three of these banks have already collapsed this year, while others are on the brink of failure.
The analysts suggested that regulators may temporarily ban short selling to prevent a contagion effect and restore confidence in the banking system. They noted that such a move has been done before during the 2008 financial crisis and the 2020 coronavirus pandemic.
However, they also acknowledged that banning short selling may have unintended consequences, such as reducing market liquidity and efficiency. They said that regulators should weigh the costs and benefits of such an intervention carefully.