City looks for more bank mergers

How quickly the wheel turns. A year ago when Bank of Scotland launched its hostile bid for National Westminster Bank, there were cheers in dealing rooms right across the Square Mile. Twelve months on, and with NatWest having gone to Royal Bank it is the turn of Peter Burt, the Bank of Scotland chief executive to feel the heat.

How quickly the wheel turns. A year ago when Bank of Scotland launched its hostile bid for National Westminster Bank, there were cheers in dealing rooms right across the Square Mile. Twelve months on, and with NatWest having gone to Royal Bank it is the turn of Peter Burt, the Bank of Scotland chief executive to feel the heat.

His attempts to claim that the record £535m pre-tax profits chalked up in the first half of this year proved that the bank was under no pressure to sell, fell on deaf ears. Having seen the numbers yesterday, analysts are more convinced than ever that the growth momentum at Bank of Scotland is slowing and believe the bank should cave in to the next willing buyer to knock on Mr Burt's door.

Never mind that Bank of Scotland is so efficiently run that none of the potential bidders favoured by the market, such as HSBC, Barclays or Halifax, believe that such a deal would make economic sense.

Mr Burt is not the only banking chief executive to witness first hand how quickly the tables can turn. Bank of Scotland is not the only banking institution which 12 months ago was seen as a highly plausible predator but which is now regarded as more likely to be someone else's prey.

Those with slightly longer memories remember that it was not so long ago - 1997 to be exact - when Abbey National was in discussions about an agreed takeover bid for NatWest. Now respected City analysts such as Richard Coleman at ABN Amro are openly calling Abbey the "new NatWest". Ian Harley, the chief executive, finds himself the target of a whispering campaign while the bank is touted around as the next takeover target for a newly invigorated Barclays or increasingly desperate Lloyds TSB.

Barclays' recent move to take over the Woolwich, the most highly rated of the converted building societies has put banking consolidation back on the agenda.

But the circumstances are very different from the late 1990s when consolidation fever drove share prices to such heights that no-one felt under any pressure to actually do a deal. This time around there is a real anxiety in the air. The fat retail banking margins which investors assumed would last forever are now visibly melting before their eyes. When the values of their largest holdings are falling, institutions get jumpy and start calling for chief executives heads.

After the panic last year, when investors dumped banks along with other Old Economy stocks in favour of the glamour of TMT, investors have cautiously returned to the sector. But they are not buying indiscriminately.

Only two UK banks, Royal Bank of Scotland and HSBC have seen their share price bounce back to well above last year's levels. RBS because it seen to be more than fulfiling expectations of the turnaround potential at NatWest. HSBC because it is now seen as in the same exalted bracket as Citigroup of the US - a global bank riding the jetstream above the turbulence that buffets smaller domestically focussed banks.

For the others, life is uncomfortable indeed. The market has been particularly savage in its verdict on the mortgage banks which are locked in a seemingly endless price war. Less so on the clearing banks whose corporate and wholesale lending businesses are more robust.

Of the mortgage banks, Woolwich has been the first to see the writing on the wall. John Stewart, Woolwich chief executive was the first to realise that the bank had to change radically if it was to survive in a more competitive market. He was also smart enough to realise that while his IT strategy looked good on paper, successful execution was another matter. In the final analysis, he was better off selling Woolwich while the market still believed the hype.

For others it may be too late. Bradford & Bingley has been touted around by its advisers Goldman Sachs and ABN Amro for over a year but no-one wants to buy. Alliance & Leicester likewise is something of a wallflower at the consolidation ball

It is in the awkward middle, that institutions are most impatient for action. Bank of Scotland is paying the price for having raised investors expectations and then having been unable to deliver. Compared with the juicy dish that NatWest would have been had Bank of Scotland not Royal Bank got it, selling more mortgages to AA customers unfortunately does not have the same zing.

When Ian Harley took over at Abbey from Peter Birch, the group had a series of big deals under its belt and seemed well positioned for more. It was more highly rated than NatWest or Barclays and could have had its pick of partners. But Mr Harley was cautious, some would say too much so, and has preferred small bolt-on acquisitions to the big transforming deal. As pressure has mounted, Mr Harley has become increasingly wayward announcing a raft of initiatives, culminating in the recent £2bn acquisition of Scottish Provident, the life insurance group.

These have all been aimed at raising the share price, and by that token have failed. The calls for his resignation come from those who believe that he is the only obstacle to Abbey being taken over by Lloyds or Barclays.

Some would say that a deal between Bank of Scotland and Abbey National would solve both their problems. Abbey would get the broader banking expertise it lacks while Bank of Scotland would get the balance sheet scale it needs to carry on growing at the rate it has for the last 10 years.

But judging from Mr Burt's dismissive remarks yesterday that it not going to happen as long as both he and Mr Harley are in their jobs.

Ironically, consolidation may not be the easy answer many fondly imagine. Few of the recent deals have done much to energise flagging share prices and for good reason. The fundamental problem with Britain's banks is that the vast majority have had it too easy for too long. Now they are faced with real competition, they are floundering about with little idea of what to do. As always the City's pat answer is to do a deal. It is so much easier than trying to work out what the customer really wants.