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The Anglo File: U.K. Banks Need to Be Better as Well as Bigger

Consolidation is but one threat looming over the notoriously coddled British banks.
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LONDON -- "Like a kick in the butt, the force of events wakes slumberous talents," the U.S. novelist Edward Hoagland wrote.

Having received its kick in the butt from the

Bank of Scotland's

surprise bid for

National Westminster Bank

, the U.K. banking industry will be hoping it can discover its hidden talents in order to withstand the relentless squeeze between government and technology.

Certainly, the full repercussions of Friday's 23 billion-pound bid by Bank of Scotland for its much larger rival NatWest have yet to be felt. Being the first unsolicited bid for a U.K. bank, this effectively puts the whole sector in play.

Credit Lyonnais'

banking analysts, for example, have placed all of the U.K.'s commercial banks on buy or trading-add recommendations.

NatWest said in a statement that Bank of Scotland's bid was "unsolicited, unwelcome and ill thought-out." By most accounts, the offer is cheap and already several other institutions --

Royal Bank of Scotland




Abbey National

-- have stated they are watching the situation closely. The competition authority has indicated it has no problem with a foreign white knight and, according to newspaper reports, possible European candidates include France's

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Societe Generale

and the Dutch bank

ING Barings


A Cut Above the Rest

While the offer is well-timed, what disappoints most observers is the lack of details in Bank of Scotland's bid. The offer is conditional on a number of factors such as the dropping of NatWest's unpopular bid this month for U.K. insurer

Legal & General

, yet there were no specific figures on potential cost-savings.

According to the investment bank

Williams de Broe

, if Bank of Scotland reduces the cost/income ratio of NatWest's U.K. retail operations by 10% over the next three years, synergies could total around 450 million pounds on an annualized basis from that source alone. Royal Bank of Scotland is reportedly proposing to cut 30,000 jobs from NatWest, twice as many as Bank of Scotland. The large number of job losses would cut as much as 1 billion pounds from the costs of the combined entity.

This looks fine on paper, but in practice? "Yes, more size means you can cut costs, at least in theory, but many times firms just don't follow through on the execution side," says Jonathan Iseson, the general partner of hedge fund

Blue Water Partners

. "Mergers of size are harder in real life than the bankers' proposals." Iseson is currently neither long nor short any U.K. bank stocks.

Even if the banks were to succeed in cutting all the costs, there remains the question of whether such savings would be great enough to keep the commercial banks ticking along in the lifestyle they are accustomed to in an increasingly hostile environment.

Compared with their continental counterparts, British banks are relatively lean and profitable. First-half results for banks in fiscal 1999 were at record highs, with even NatWest (or NatWorst as it is less formally known) beating expectations with an 18% rise in pretax profits to 1.14 billion pounds.

These burgeoning profits have helped the U.K. bank sector outperform the

FTSE 100 Share Index

by 17.6 percentage points over the past 12 months. By contrast, the U.S. bank sector has underperformed the Dow by 11.3 percentage points over the previous 12 months. Yet not everyone is happy about such huge profits.

Making Profits or Profiteering?

On Monday, Chancellor of the Exchequer

Gordon Brown

told cheering delegates at the

Labor Party Conference

that he would continue to punish cartels and "old-boy networks" in favor of the entrepreneur. "The enemy is not the market but monopolies," Brown said, and there was no doubting that it was the banks he was referring to.

Brown stated that he has every intention of implementing in full the proposals that will be laid out by Don Cruickshank in his government-backed inquiry into the banking industry, which is expected to be released at the end of this year. Cruickshank recommended in his interim report last month that the banking industry should no longer be excluded from the U.K.'s general competition laws, and the

Financial Services Authority

should be encouraged to promote competition through regulation of the industry.

Brown also wants more transparency in how banks charge their customers to create league tables that consumers can use to see which banks are cheapest for specific services. If the banks don't do this themselves, Brown says, he will use regulation to do it for them.

The government is also looking into practices by mortgage lenders in a market that

Barclays Bank

expects to top 100 billion pounds this year. The mortgage trade organization acceded this week to demands that home loan lenders should be policed by the Financial Services Authority, and the government has proposed a summit of the lenders, consumer groups and the regulator to try to eradicate some of the industry's dubious practices.

Technology is also putting enormous pressure on the commercial banks. New entrants such as


Internet banking service,


, have much lower costs than the traditional lenders and now offer consumers the lowest standard variable mortgage rate of 5.59%.

Barclays is in the process of slashing 6,000 jobs from its retail and corporate banking divisions. The management specifically blamed the spread of telephone and Internet banking for the job losses.

The Bank of Scotland's bid for NatWest looks set to give the industry a much-needed kick in the rear as it faces up to the twin forces of technology and a government determined to stamp out the much-loved secrecy of the banking world. One wonders whether this kick will be hard enough to be felt through the notoriously thick skins of British bankers.