LONDON -- When is profit a bad thing? When a U.K. bank is making it, apparently.

On Monday, a government-commissioned review of the U.K. banking sector was released after 16 months of inquiry and preparation. Don Cruickshank, a former telecom regulator and author of the report, claimed that customers are paying between 3 billion and 5 billion pounds ($4.73 billion to $7.88 billion) too much per year for banking services, a sum equivalent to between 7% and 12% of revenues in the sector during 1999.

Cruickshank reserved most of his ire for the country's four largest banks,

Barclays

(BCS) - Get Report

,

National Westminster

(NW)

,

Lloyds TSB

and

HSBC

(HBC)

, which account for 83% of the personal accounts in the U.K.

The reason Cruickshank gives for the special treatment that the banking industry enjoys is the existence of an "informal contract" between the governments and banks. In return for cooperating in the delivery of government objectives, the banking industry has largely escaped the rigors of normal competition.

Show Me the Competition

The review focused on whether competition was effective in three parts of the banking market: money transmission, services to personal customers and services to small and medium-sized businesses (SMEs). Cruickshank's answer was a resounding "no" in all three cases.

For example, in money transmission, the review notes that there are artificial barriers to entry; retailers incur high costs for accepting credit and debit cards; charges for cash withdrawals from ATMs are up to six times their cost; and there exists an inflexible payments system that is incompatible with the functioning of e-commerce.

The key recommendations that Cruickshank makes, but which it should be stressed he has no statutory powers to implement, include a referral of SME banking services to the

Competition Commission

and a possible forced selloff of this part of the banks' business; a new body called

Paycom

to regulate the money transmission business; and that all banking mergers should be referred to the competition watchdog.

Certainly, the report didn't pull any punches and was worse than what any in the banking industry had feared. The predictable result was that banking shares of the four largest banks fell from the opening bell. Yet by the end of the day, most had recouped those losses, with Barclays ending up 1.1% at 15.19 pounds, Lloyds unchanged at 601 pence and NatWest up 0.3% at 11.96 pounds. (In New York, BCS closed up 1 3/4, or 1.86%, at 95 3/4; HSBC closed up 1 3/8, or 4.4%, at 57 7/8.)

Heard It on the Grapevine

One reason for this rise was that on Friday, the shares of these banks fell significantly in advance of the report, and much of the findings already were priced into the share prices.

"I was concerned when I first read the headlines, but in the long term, I don't really see this report making much of a difference," says Ed Firth, analyst at

Credit Lyonnais

. "

Cruickshank is throwing a lot of mud, hoping some of it will stick."

For example, the issue of money transmission has been considered long overdue for change, and as such, already was perceived to be a long-term threat to banks' profitability. Similarly, SME banking services, with the four largest banks cornering most of the market, also have been regarded as fairly oligopolistic and would need to be addressed at some time.

There is some agreement that the selloff in bank stocks as investors fled the sector into New Economy stocks has been overdone, and fears that the banks' franchises are under threat from new entrants is misplaced. Since the beginning of March, the

FTSE

bank sector has risen just 2.7%, compared with a 6.1% rise in the FTSE 100.

While this may be true, the Cruickshank report should not be summarily dismissed as one written by a curmudgeon with a grudge against the sector. Immediately following the report, the government announced that it would take the report's advice and refer the SME business to the competition authorities.

In addition, the public perception of the banks is not good, and with the U.K. budget on Tuesday, Chancellor of the Exchequer

Gordon Brown

may use the report as justification for a windfall profits tax, which is unlikely to trouble anyone but the banks themselves.

The chancellor undoubtedly likes British companies to profit -- just not quite so much as the banks are doing.