In its last-ever annual review of market developments in the sector - from 1 June responsibility for banking supervision transfers to the Financial Services Authority - the Bank warned UK banks should lend prudently. Banks have historically taken on significant proportions of bad debt in the late stages of the economic cycle, the Bank of England said.
The Bank also said there were regulatory lessons to be learned from the Asian crisis, although it noted that the UK banks had, to date, managed their exposures to the region well.
In its annual review, the Bank said: "Less consolidation was seen in the banking sector during 1997 than in the previous year, although the conditions remain favourable and there was intense speculation about possible mergers and acquisitions."
Michael Foot, who will become managing director and head of financial supervision at the new FSA, remarked that if a man from Mars landed in the UK, he would see plenty of opportunity for cost-saving mergers. "One would be surprised if there weren't more of this type of merger," he added.
Mr Foot, who is also an executive director of the Bank of England, said he could envisage a situation where there was greater co-operation between insurance companies and banks. He also pointed to the tough competition in the mortgage market. In its review, the Bank predicted: "The small residential mortgage lenders could be faced with increased competition from the bancassurers [companies providing both banking and insurance services] who ... have yet to fully exploit in-roads into the mortgage market."
The Bank said there was little evidence of a repeat of the Eighties-style lending activity which led to significant bad debt losses in the recession of the early 1990s. "Nevertheless, the late stages of the cycle have often proved in the past particularly critical for banks: a significant proportion of what ultimately turn out to be bad debts are put on the books at around that stage," it said.
According to the Bank, the UK economy could now be past its cyclical peal after "a further year of above-trend growth".
The recent upheavals in Asia have led to a renewed focus on worldwide financial stability, the Bank said. Mr Foot said that, in the light of the Asian crisis, the Bank would be asking the international community to revisit the 25 "core principles of banking supervision" issued by the Basle Committee on Banking Supervision.
Mr Foot noted that the scale of the exposure of UK banks to the troubled Asian region was "relatively modest". He added: "Many of the banks with the largest exposures tend to be the most professionally involved in the region."
The Bank said it had decided to drop its so-called "provisioning matrix", which was introduced in 1987 to give guidance on provisioning levels for country debt. The Bank said the matrix had "become increasingly incompatible with risk-based supervision".
The Bank repeated its warning that firms which were unprepared for Emu or the year 2000 could face regulatory sanctions.