Happy shoppers made happy borrowers. But is the banks' high street boom over?

The big-spending British consumer has made billions for the likes of Lloyds TSB and Barclays, but not for much longer - thanks to increased competition and state intervention, says Jason Nissé
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The Independent Online

One trillion pounds is a lot of money by anybody's standards. It is equal to the total GDP of the UK. It is nearly 10 times the worth of Britain's largest company, BP. And it would buy you 25,000 Wayne Rooneys.

One trillion pounds is a lot of money by anybody's standards. It is equal to the total GDP of the UK. It is nearly 10 times the worth of Britain's largest company, BP. And it would buy you 25,000 Wayne Rooneys.

It is also the amount of money British households owe to their banks. It is an astonishing total which has politicians, economists and the Governor of the Bank of England fretting.

But for the lenders, it has been the engine of one of the most successful periods of profitability in British banking history. It is estimated that the big UK lenders banked nearly £9bn of revenues last year from consumer credit (and that does not include mortgage lending), reaping about £2.6bn of profits. For some banks, the UK consumer is responsible for nearly a quarter of their profits.

However, with the big banks all about to unveil their half-year figures in the next two weeks, it seems that this boom could be over. Though not in the way most people expect.

There is not going to be an almighty crash, with hundreds of thousands of people being bankrupted and families being thrown into the street. The market may slow, but lending will not stop. It is competition that is killing the goose that laid the golden egg.

"The most serious bear argument against the banking sector is the lack of growth and potential for earnings downgrades as a result of a consumer slowdown and increasing competition," says Robert Law, a banking analyst at Lehman Brothers.

The consumer debt market has in the past been dominated by a handful of big banks. If they want a mortgage, customers tend to shop around, but if they want an unsecured loan to, say, buy a car or pay for a holiday, most people go to their bank. This has meant that the big four lenders - Lloyds TSB, Barclays, HSBC and NatWest (now part of Royal Bank of Scotland) - have had the lion's share of the business.

For smaller purchases, a lot of people borrow money on their credit cards. Again, the big banks have dominated, with Barclays leading the way through Barclaycard, the UK's first, and still most successful, credit card. These are extremely profitable businesses, although the banks are quite coy about revealing how profitable. In a recent report, analysts at Morgan Stanley reckoned that Barclaycard delivered £462m of profits on its own last year, 12 per cent of Barclays total pre-tax income.

But in the past few years, life has started to get more difficult for the big lenders. In the market for unsecured loans, the so called "direct lenders" have started eating into the high street banks' market.

We are all aware of the marketing bumf - it comes through our doors and falls out of our newspapers and magazines every day. These lenders come in all shapes and sizes - from specialist car finance companies, such as Accept Car Credit or Car Credit UK; to smaller or foreign banks trying to take market share from the big lenders, such as Alliance & Leicester and Citibank; to supermarkets and insurers aiming to break into the banking market, such as Tesco, J Sainsbury or Liverpool Victoria; and subsidiaries of the big banks operating under different names, such as RBS's Lombard Direct, Direct Line and Churchill or Lloyds TSB's recently acquired Goldfish. If you want a personal loan these days, there are more than 400 offers to choose from.

This competition is starting to change the dynamics of the sector. "The direct lenders have really started to make an impact in the last year or two," says Andy Bayes, the head of loans at Alliance & Leicester. "In the last 12 to 18 months the big banks have had to reduce their headline rates and have vastly increased their marketing."

Robin Down, a banking analyst at Morgan Stanley, has made a detailed study of the impact this has had on the market. "We see a material squeeze on consumer credit profitability as old, high-spread loans are replaced by new, lower-spread lending," he argues.

And he has figures to back this up. They indicate that, despite the interest rate rises over the past year, the average rates on new personal loans have fallen. And the margin that banks are making on new loans has collapsed, from around 6 per cent to around 3 per cent.

The effects of these collapsing margins will take some time to make themselves felt, but analysts reckon they could knock over £1bn a year from banking profits. But that's not the end of the bad news. When you take out a personal loan, the bank will offer you credit protection insurance. In many cases this insurance is included in the price of the loan, sometimes it is compulsory. It is also a massive source of profit for the banks, generating up to £4bn of income a year - and, say the Consumers' Association and many personal finance experts, often a rip-off.

"The banks have become a bit like Dixons," said one analyst. "It sold electrical goods cheaply and made its profits on the extended warranties. Some of the loans these days are sold as loss leaders and the profit is made on the protection insurance."

The House of Commons Treasury Committee has slammed credit protection insurance and called on the Office of Fair Trading to investigate it. The OFT has passed the buck to the Financial Services Authority, which has yet to pick up the baton. But few doubt that one of the regulators will take the banks to task over this insurance soon, reducing a big source of income.

And it is not only on unsecured loans where the banks are under pressure, it is on credit cards as well. Barclays has yet to recover from the gaffe made by its chief executive, Matt Barrett, at the Treasury Committee last year when he said he would not recommend borrowing on a Barclaycard because it was too expensive. Competitive pressures from the likes of Egg, HBOS and US group MBNA, have forced Barclaycard to cut its rates and offer extended 0 per cent lending periods. But the incumbents are still losing ground and MBNA has quietly become the second largest issuer of credit cards in the UK. Though this is still a highly profitable business, the estimated average gross margins on credit cards have fallen from nearly 13 per cent at the beginning of 2002 to under 11 per cent now.

To add to the misery, the Competition Commission, which is currently investigating the store card market, has said it may extend its remit to credit cards.

The banks are also under pressure over how much they charge stores to process their credit card transactions. Again, this is a market dominated by the big banks and it is a £1bn-a-year business. The OFT has said it is unhappy about the rates charged by the banks and is putting pressure on them to reduce the fees. Morgan Stanley estimates current rates of 0.7 per cent charged by the banks could halve.

British banks enjoy a return on equity of around 18 per cent, around 50 per cent higher than French banks and almost double the return across most of Europe. This may be because they make so much more out of consumer lending.

But the gravy train could be about to hit the buffers.