Banks expect a season of bumper returns

'Excess' profits will put them on collision course with consumer groups and politicians
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To the anger of MPs gunning for the fat cats of the City, Matt Barrett, chief executive of Barclays, famously told the Treasury Select Committee two years ago that "excess profits" was simply not a term he recognised. Since then, Mr Barrett may well have got out his dictionary, as the slightly less loaded term of "record profits" is likely to be one of the phrases tripping off his lips when he unveils Barclays' annual results on Thursday.

Indeed, if analysts' forecasts are to be believed, almost the entire banking sector is gearing up for a reporting season in which bumper profits are likely to be the top line of almost every results presentation.

The situation may well cause pound signs to light up in shareholders' eyes. But profits that are equivalent, in the case of HSBC and Royal Bank of Scotland, to the output of the entire annual output of Bulgaria, are bound to put banks firmly on a collision course with politicians and consumer groups.

Britain's banks have long been public enemy No 1, and the suspicion that they profiteer at the expense of ordinary people was given official weight by the government-sponsored report into the banking sector by Don Cruickshank in 2000.

Having investigated for two years, Mr Cruickshank, a former telecoms regulator, declared that banks operate a "complex monopoly" and, as a consequence, make "excess profits".

It may be a term that flummoxes Mr Barrett, but it is one that seems to describe the striking difference between the profitability of the UK banking sector - which makes a return on equity of more than 20 per cent - and other parts of the economy, where companies barely get into double figures.

Robin Down, an analyst at Morgan Stanley, said: "If one or two banks say they are making these sorts of returns, you could say it is due to a particular expertise. But when the whole sector is saying it, that is suggestive of excess profits."

Britain's banks are among the most profitable in the world, outstripping the lenders of Germany, where the sector is in crisis, and France and, in many cases, even American financial institutions.

According to Philip Middleton, head of retail banking at accountants Ernst & Young, Britain's banking market as a whole is "highly competitive", with consumers able to ferret out as good a deal as could be found anywhere in the world.

And yet the major players manage to "display the features of an oligarchy, because the dynamic pulse of UK retail banking is consumer apathy," Mr Middleton said. Unlike in almost any other major market, Britain's so-called Big Four banks - Lloyds TSB, Barclays, Royal Bank of Scotland and HSBC - control more than 70 per cent of the current account market. Mr Cruickshank highlighted the issue as a possible factor creating barriers to new entrants, who could otherwise act as competitors, driving down the price.

Such a view has been partly offset by a piece of research from consultants Oliver Wyman, showing that on a basket of products, such as an overdraft and a current account, British consumers pay less than half of what such services cost in most other developed countries (see table above).

Yet British lenders are undoubtedly making a mint from certain products. Mortgages, where thousands of customers remain on poor deals, and credit cards, where the sheer complexity of the market enables providers to charge interest at many multiples of the Bank of England base rate, have been huge drivers of profitability as the housing market has boomed in the past few years and individuals have ratcheted up unsecured debt.

In a move that must also reflect the dominance of a few major players, British banks also charge much more swingeing penalties for transgressions, such as exceeding overdraft allowances, than are normal in other countries.

Politics is probably one answer to why Britain's banks rake in far more profits than those in other countries.

"On the Continent, governments see banks are part of the social fabric. In Germany they are expected to be very into small business lending - which can be very unprofitable - and they are very overstaffed," Mr Middleton said.

Continental banks are further squeezed on price by a strong mutually owned sector. In contrast, in Britain, building societies have all but died out, and, many would say, those still existing behave like profit-making companies.

Surprisingly, even in the United States, government interference is much greater than in the UK. Federal law prevents banks from opening and closing branches with the freedom of their UK counterparts, and also dictates elements of their lending policy.

US lenders have to contend with these restrictions while at the same time struggling to build up national networks. In contrast, in Britain, banks have been given a very free rein to run themselves for their shareholders. Indeed, the unspoken view of this country's regulators is that after the mess major lenders such as Barclays found themselves in, thanks to the recession of the early 1990s, allowing major lenders to generate huge coffers of profits every year ensures the stability of the wider economy.

It is a freedom that banks have made full use of, with cost-cutting having been a major driver of profitability in the past decade. Since the early 1990s, 100,000 employees of banks have been expunged. The system is so automated now that if the current volume of financial services in the UK had been carried out in the 1960s, it would have taken the entire working population at the time to cope with the demand.

Another factor - grasped more than 10 years ago by Sir Brian Pitman, a former chief executive of Lloyds - is that providing services for ordinary people tends to be far more profitable than corporate banking because consumers can be charged higher prices for products than business customers. As a consequence, retail banking accounts for more than half of the UK banks' profits - much more than on the Continent.

One banking source said: "The question is, where does the value go? In the UK, surplus capital goes to shareholders and looks like excess profits.

"In Germany, more goes to employees and to corporate customers."

Shareholders should enjoy the situation while they can. While analysts forecast a month-and-a-half-long season of record profits for British banks, also plotted on their graphs are falling lines to denote the trajectory of profits margins, not just this year but for the next few years.

This is partly because consumer spending is expected to slow, and will therefore become a smaller slice of the pie with less profitable corporate banking making up more of the revenue growth.

Those pesky politicians are also playing their part in taking a lump out of banks' profits. The Treasury Select Committee had another duel with Mr Barrett last October, this time on credit cards, and is forcing through changes to make the products more transparent - and probably less profitable.