Although I think there are opportunities in banking, there are many, many risks. So today I asked some Fools who cover the banking sector this question:

If I want invest in banks, what is the biggest threat I should be wary of? Commercial real estate? Credit card losses? Falling housing prices? Derivatives? Government regulation? Something else?

Matt Koppenheffer: If only I could say that a single issue facing the banks was the biggest threat. While banks like Citigroup and Bank of America (NYSE:BAC) that were slammed by the financial crisis may have seen the light when it comes to making loans that borrowers can actually pay back, legacy loans will continue to be a problem. This extends from the already problematic mortgage and credit card loans to the commercial loans that are on the edge of their own cliff.

But loans are only the beginning of it all. As long as derivatives like credit default swaps stay unregulated, banks will likely continue to chase them with reckless abandon. As of yet, I don't see any reason why we can't have a repeat of AIG. Meanwhile, many of the banks that we're referring to here -- Bank of America, JPMorgan Chase (NYSE:JPM), etc -- have gone from "too big to fail" to "too bigger to fail" during the crisis, making the stability of the system as a whole even more tenuous than it once was.

And if the government does finally get in gear to crack down on banking abuses, investors may suddenly see the bottom line for the bank they've invested in start to dry up. All in all, between the myriad issues I've noted above, along with the massive run-up in banking stocks over the past eight months, I see investing in big banks right now as a very daunting mine field.

Morgan Housel: Malcolm Gladwell wrote a great article on the trouble with information, where he points out that if Enron fully disclosed its off-balance-sheet workings, its annual reports should have been over three million pages long. Something similar can be said about banks.

That said, I think the biggest risk is the issue of disclosure and transparency. I like to look back at banks' annual reports from 2005-2006 and, with the awesome advantage of hindsight, see if I can find the landmines that eventually blew them apart. Nine times out of ten, you can't. They just don't talk about them. A few examples:

  • Open Citigroup's (NYSE:C) annual reports from 2005-2006, and try to find the words "liquidity put." (I'll save you the time: they aren't there). Yet liquidity puts forced Citigroup to repurchase $25 billion of CDOs at full price. At the time, the bank had about $115 billion in equity, so this was something where almost a quarter of the company's equity was at stake, yet they didn't even mention it in the annual report.
  • Read Bear Stearns' annual filings from the boom years. Try to figure out how much of its repurchase agreement financing was termed at 24 hours. They don't talk about it. But this literally made it so the bank could go from "well capitalized" to bankrupt within minutes. Very few people knew this until it was too late.
  • Crack open AIG's (NYSE:AIG) annual reports from 2005-2007, and see if you can even remotely begin to comprehend how its derivative operations worked. Within minutes you'll be banging your head on the table, begging for mercy.

So then I ask, OK, if even with hindsight advantage, I still can't figure what happened in the past, how do I expect to do better going forward, especially now that banks are larger and more convoluted today than they were back then? I sure as heck can't, and that's why I stay far away.

Alex Dumortier: Despite multiple series of writedowns and capital raises, the banking sector still faces multiple risks, including:

  • Commercial real estate: Billionaire real estate investor Sam Zell recently told a gathering in Chicago that office and apartment building owners would be able to fill their properties by 2011 or 2012 ... at prices 30% below their peak. Perhaps that's the sort of assumption that prompted Morgan Stanley (NYSE:MS) to turn over Crescent Real Estate Equities to Crescent debtholder Barclays (NYSE:BCS) last week. The action suggests Morgan thinks the properties are worth less than their debt and that the equity value will remain negative for the foreseeable future.

However, I fear the submerged part of the credit risk iceberg that could put a new hole in the hull of the S.S. Banking Sector is the mass of prime borrowers that are beginning to default on mortgage and credit card loans:

  • Prime borrowers taking on water: According to a survey by the Mortgage Bankers Assocation, 14% of home borrowers were either delinquent or in foreclosure in the third quarter – the highest level since the group began this survey in 1972. Significantly, 55% of loans in foreclosure during the quarter were made to prime borrowers against 37% that were subprime. That shift looks unlikely to reverse as prime fixed -- rate loans also account for a majority (54%) of the increase in loans at least 90 days past due, but not yet in foreclosure. Factor in what I believe will be stubbornly high unemployment and you have a recipe for pain at mortgage lenders such as Bank of America, JPMorgan Chase, or Wells Fargo (NYSE:WFC).

Are these (and other risk factors) reason enough to steer clear of banks? Not necessarily, but they do highlight the importance of requiring a margin of safety, i.e. paying less for shares than a conservative estimate of their intrinsic value. Investors' best bet to achieve that is to look beyond the front-page headlines at smaller, well-run institutions.

What your biggest banking fear? Join the roundtable discussion in the comments section below.

This roundtable article was compiled by Anand Chokkavelu, who owns shares of Citigroup. The Motley Fool has a disclosure policy.