Banks walk tightrope: Return to big profits could backfire in competition changes

AS THE banks look forward to their best annual results season for several years, they are uncomfortably aware that they are about to be hit by a fresh wave of competition from Britain's building societies.

This could mark the high point for bank shares, which have more than doubled in the past two years.

The Treasury is understood to be on the point of relaxing the rule that confines the societies to drawing no more than four-tenths of their working capital from the money market. The rest must come from savers, who these days demand higher rates of interest.

'Without that constraint, the societies will be in a position to squeeze the profit margins the banks make on mortgages - one of their fastest-growing areas,' said David Pountney at Collins Stewart, one of the City's leading banking analysts.

Ironically, the banks may be only too happy to join in a price war, to help dissipate their profits. As our table of analysts' forecasts shows, the end of the recession will be marked by a sharp rebound in profits. But, unlike their behaviour in past recessions, the banks have not relied entirely on write-offs to improve profits. They have shrugged off widespread public criticism to raise charges and cut costs, mainly by sacking thousands of staff.

This is causing distinct unease among bank directors who remember the ferocity with which governments - even those previously thought sympathetic - can turn on the sector if they feel it is making too much profit.

Those fears - and shareholders' appetites - have been whetted by results already out from TSB Group and Royal Bank of Scotland Group, which have earlier year-ends. Both reported a healthy rebound in profits and dividends, increased by 20 per cent and 25 per cent respectively.

But analysts were quick to point out that these were one-off improvements - especially in the dividends. The general run of dividend increases is likely to be in the 10-15 per cent range, with Barclays' investors believed to be steeling themselves for little or no change.

'The key is going to be the dividend increases,' said Tim Clarke, analyst at stockbrokers Panmure Gordon. 'Standard Chartered and HSBC - Hong Kong & Shanghai Banking Corporation, which includes Midland - might keep up with Royal and TSB, but that is because they are mainly operating in a very different economic environment, the Far East.'

As his cautious forecasts suggest, Mr Clarke sees banking in long-term decline. He argues that it is a mature industry where the main growth prospects in recent years have either come from lending in untested geographical regions such as South America, or from entering new activities such as hire purchase, property lending, mortgages and stockbroking. Both initiatives involve high risk and both have ended in tears.

However, the problem underlying the forthcoming results is much more fundamental. After years of recession, people and - more worryingly - companies just do not want to borrow.

As Chris Ellerton, banking analyst at SG Warburg Securities, said: 'People who buy bank shares now are not going to make much in the long term.'

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