Don Cruickshank, the head of the banking review, yesterday urged the Government to put a stop to a further consolidation in the banking sector, arguing that the personal current account and small and medium-sized markets are already too concentrated.
Speaking as he unveiled his long-awaited review of the banking sector, Mr Cruickshank said that aspects of the Royal Bank of Scotland takeover of NatWest raised serious concerns. The two banks' combined share of the small business market in the North-west of England was over 50 per cent.
Mr Cruickshank accused the big four banks of abusing their position at the core of the UK banking systems to make excessive profits at the expense of retail and business customers.
"Current returns are very high. The 1999 results, suggest that profitability is £3bn-£5bn higher than it would have been if there were effective competition. All the supernormal profits come from servicing personal customers and small businesses."
He said that new competition, particularly in the personal sector, would bring the rate of return for the industry as a whole down to a more normal level. This, he judged, should be at or near the cost of capital - currently 17 per cent. However, in order for that to be achieved, the Government would have to take action to remove barriers to entry which are preventing newer, more efficient banks breaking into the market.
The banks on average make around 28 per cent return on equity, with Lloyds TSB regularly returning in excess of 30 per cent. This implied bank shares falling another 35 per cent on February levels, according to the report.
The Government moved swiftly to act on one of Mr Cruickshank's findings by referring the provision of small business services to the Competition Commission.
Gordon Brown, the Chancellor, who commissioned Mr Cruickshank's report 16 months ago will be giving a fuller response to his recommendations in his Budget speech today.
In all three areas Mr Cruickshank was asked to investigate - money transmission, services to personal customers and services to small and medium sized businesses, he said that he found evidence of competition problems. These he attributed to the high degree of concentration of market power in the hands of the big four banks who between them hold 68 per cent of the current accounts in Britain.
They also dominate the running of the interbank payments systems which handle all the cheque credit card and debit card transactions in the country with the result that they are inflexible and hard for newcomers to penetrate, as well as failing to keep pace with the demands of e-commerce.
The banks, he says, make £750m a year out of interchange fees alone.
Mr Cruickshank said: "Network effects mean that there is a natural limit to the extent to which competition is possible between payment systems. As a result inefficiencies can persist for years and payments systems can be run for the benefit of those who control them rather than the public interest."
He went on to describe the UK banking system as providing material for a text-book study into market failure. "All the competition problems you could find are there."
The former telecoms regulator wants to see a new payments regulator, PayCom, whose task will be to ensure that the money transmission system is opened up and the big banks prevented from abusing their power to keep newer more efficient banks out as they having been seeking to do over automatic teller machines (ATMs).
However, he also makes clear that he is against both "behavioural and product regulation", putting himself at odds with the Government which instinctively favours both.
Mr Cruickshank said that he expected the Competition Commission would have to seek divestment of the small business operations of a number of banks to allow new competitors into the market.
His attack goes wider than individual institutions however, much to the annoyance of the financial services regulator, whose chairman Howard Davies was abroad yesterday.Mr Cruickshank said he did not blame the banks, saying that it was the fault of the regulatory system which allowed them to get away with "writing their own rules". He said: "In their position I would do the same."
Much of the analysis underpinning the report relates to what Mr Cruickshank calls "the informal contract" between successive governments and banks. This, he said, allowed banks to escape the full rigours of competition in return for subjecting themselves to more detailed scrutiny designed to reassure the public that savings were being well looked after.
However, objectives have become blurred and the regulators have slipped into a cosy acceptance that protection of the public means that banks should not be allowed to fail.
Mr Cruickshank said he expected his findings to meet stiff opposition from all quarters. "It is hard to change culture. It is hard to change habits. It would surprise me if there were not a few wins and a few draws. I hope there won't be any losses because if there are it will be the consumer that loses."
Concern in the City was muted. After an initial fall, bank shares mostly ended up on the day. James Alexander at Commerzbank said: "He seems not to have been to hard on the personal sector... PayCom, the Competition Commission, possible splitting of the business is way in the future. However, I am worried about what the Chancellor might have to say [today]."
The report met predictable hostility from the banks. Andrew Buxton, president of the British Bankers Association and former Barclays chairman, attacked Mr Cruickshank's headline-grabbing figure of £3bn-£5bn excess profits as the creation of "spin doctors".
But, equally predictably, there was strong support from consumers and small business lobbies. Ian Peters, deputy director general of the British Chamber of Commerce, welcomed yesterday's referral, while Sheila McKechnie, director of the Consumers' Association, demanded a "crack-down" on anti-competitive behaviour by the banks.