Commentary: The Not So Splendid Isolation Of British Banking

The big Swiss banking merger is shining a harsh spotlight on Britain's banks. With European monetary union around the corner, the Continental banks are extending their cross-border reach and beefing up global businesses. Meanwhile, the British are retreating into their traditional insularity and focusing on their very profitable domestic market. But that's a dangerous strategy. EMU will surely lead to the formation of more huge European banks that could eventually swallow up British rivals.

Germany's Deutsche Bank, Dutch banks ABN-Amro and ING, and the two remaining major Swiss banks are spending heavily on global asset management and investment banking. But except for HSBC Holdings, major British banks are focusing mainly on their home market. If they ignore the coming battle for dominance of the new single-currency banking zone, they could be bypassed by Continental giants with cheaper loans, better technology, and lower costs. "There is a risk that once Britain joins EMU, British banks will go from dominant U.K. players to [insignificant] European banks," says Richard Foster, a banking consultant at Booz, Allen & Hamilton in London.

Barclays Bank PLC and National Westminster Bank are cases in point. NatWest Chief Executive Derek Wanless and Barclays CEO Martin Taylor have dumped parts of investment banking businesses they had trouble managing. Shareholders had pressured them to get out of the risky investment banking field. Indeed, they want them to look more like retail banking giant Lloyds TSB Group PLC, which is earning around 40% on equity. By contrast, Barclays made about 24% in the first half and NatWest around 15%.

But Lloyds TSB may be a dangerous model. Britain is a mature market with limited growth opportunities. Although British banks are much more profitable than those on the Continent, margins are under pressure from rivals, says Tim Jones, head of retail banking at NatWest. A flock of newcomers, from retailer Marks & Spencer to the J. Sainsbury and Tesco supermarket chains, are nibbling at the banks' business, offering mutual funds and loans.

Yet the British banks seem to have little interest in taking stakes in their Continental cousins. "It would be tough to persuade shareholders that a major acquisition on the Continent would be in their interest," says Wanless.

By disposing of their investment banking business, NatWest will eventually free up $8 billion in capital and Barclays will realize an undisclosed sum. Where can they put some of this lucre to profitable use? As traditional branch banking is gradually replaced by phone and computer links, one route might be beefing up electronic banking in Europe. That would get around the investment in Continental branches that the British banks want to avoid. And it would play to the strengths of the British banks, which provide good service and are experimenting with interactive banking on a small scale.

THINK AGAIN? Another option for Wanless and Taylor is a merger. In fact, combining any two of Britain's Big Four would make sense. For Barclays and NatWest, which have relatively high overheads for British banks, a deal could slice some $2.5 billion from their combined $17 billion in annual costs, says John Leonard, an analyst at Salomon Brothers International Ltd. in London. Taylor approached Wanless about a combination a few months ago but was rebuffed. Perhaps Wanless ought to reconsider.

The conventional wisdom has been that the British authorities would nix such a deal if it were hostile and maybe even if friendly. A Barclays-NatWest hookup, with $680 billion in assets, would have more than 50% of the small and midsize domestic business market.

Still, the Swiss have decided that it is worth sacrificing customer choice and thousands of jobs to allow their banks the scope to become global competitors. With an eye to what has happened to their investment banks, the British government and key bankers ought to carefully consider whether Britain should be looking at its banking industry on a European rather than a national scale.

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