While brave new Europe lays the foundations for massive consolidation of its banking industry, Britain is busily churning out new banks. From Standard Life to Sainsbury’s to Marks & Spencer to Halifax Building Society, the last few years have seen a raft of new entrants elbowing their way into the sector. All right, Hongkong & Shanghai Banking Corp did take over Midland Bank, but to all intents and purposes it is business as usual under a different owner. And yes, Lloyds Bank did take over TSB Group, but they are still separate entities and, four years on, they are reportedly still having one hell of a time putting together their IT platforms. Meanwhile Banco Ambrosiano Veneto got together with Cariplo to rival San Paolo as Italy’s top bank, Bayerische Vereinsbank and Bayerische Hypo Bank created Germany’s second-largest bank, Banco de Bilbao and Banco de Vizcaya became BBV, the leading Spanish institution, and UBS’s merger with Swiss Bank Corp gave Europe its biggest bank. This wave of mega-mergers has brought a dramatic upheaval in the European league table. Between 1994 and 1998 acquisitive banks sharply enhanced their ranking. ING rose from seventh to fourth and Fortis from twentieth to fifth position. In Britain, the only bank to take to the acquisition trail in this period was Lloyds, now Lloyds TSB, which shot up from ninth to second place behind UBS. Those that stayed away from the mergers marketplace suffered, with HSBC dropping from first to third position, Barclays from fourth to eighth and NatWest from sixth to thirteenth. Economy of scale is often cited as crucial to competing in the global market. If this is the case, the UK banks are falling well behind their European rivals. Analyst John Leonard at Salomon Smith Barney estimates that, in terms of shareholder value, the mergers that have taken place in Europe should produce 15% to 20% cost savings. In Britain, on the other hand, we have former royal butler Michael Hardern spearheading a campaign to de-mutualise Bradford & Bingley and Yorkshire building societies to further saturate the market by bringing another two banks in. The real irony is that Hardern and other proponents of building society conversion could actually pull it off. “When it’s a question of remaining a mutual or taking the money, the members say give us the money,” says Philip Middleton, head of banking strategy at KPMG. “But the conversion of building societies is little more than a legal nicety. If Bradford & Bingley becomes a bank it is not going to do much different, except maybe price more competitively.” Margin pressure that comes with these new entrants should not, however, be taken lightly. Sainsbury’s, for instance, now offers a full range of banking services, while Standard Life has taken in almost £2bn in new customer deposits since it opened its doors a year ago. The new competitors have diverted more than 1% of the banking system’s deposits into their coffers. Middleton says the real problem is the glut of banks in the high street, not the number of branches they have. The main issue is on the small business side. Big corporate client business does not really come into the picture, since a company like ICI or Zeneca looking to do a bond issue would approach several international banks as well as whatever number of UK banks happened to be in the field. But Barclays and NatWest together have 45% to 48% of the small business market, so a merger of these two giants would almost certainly fall foul of the Monopolies and Mergers Commission. Besides, according to KPMG research, 93% of small businesses – which are heavily cash- and cheque-oriented – want branches. Bearing in mind that the top four UK banks already have 46% of the market by assets, compared with 18% for the big four German banks, the banks need to tread cautiously. More obvious merger candidates are the Scottish players, Royal Bank of Scotland and Bank of Scotland. Both are a bit of a conundrum in that they do nicely in their home market, but are very small on a national scale. The most innovative move from these two players in recent times has been their link-ups with supermarkets. “Royal Bank of Scotland helping Tesco and Bank of Scotland helping Sainsbury’s to run a bank is not guaranteeing their future,” says Middleton. Spain’s Banco Santander, which has a strategic cross-shareholding alliance with Royal Bank, has been diluting its stake, rendering the Scottish bank more attractive as a takeover candidate. Standard Life’s withdrawal some time ago from Bank of Scotland put this bank in the same position. HSBC made its move years ago when it acquired Midland Bank, and with its huge emerging market exposure the group’s attentions are for the medium term focused on other priorities. Barclays and NatWest are involved in a restructuring process after their hasty withdrawals from investment banking and calamitous foreign ventures. In any case, their shareholders would be best served if these two banks were to concentrate on exploiting their customer base and delivery platforms instead of on expensive acquisitions. That leaves Lloyds TSB, which has the financial muscle and the determination to start the next round of consolidation. The bank accumulates £2bn a year in surplus capital and chief exec Peter Ellwood has recognised the need to make one more big acquisition in the UK. Noises emanating from the bank indicate it is set to happen this year. It is possible that Lloyds TSB, whose black horse logo is rare north of the border, could scrape a deal with one of the Scottish banks past the competition authorities, and it has had considerable success with past acquisitions. Bringing Cheltenham & Gloucester into the fold gave it access to a high quality mortgage book and TSB is a market leader in cross-selling financial services. In both cases it was a matter of sticking to the knitting, ie, straight high-yielding domestic retail banking. Ellwood wants nothing to do with investment banking and both Scottish banks are clean in that sense. They must look most tempting. Jules Stewart is a freelance journalist.