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Business Outlook: Clearing banks on the defensive

Was there a takeover approach by Barclays to Legal and General? David Prosser, chief executive of L&G, was quoted in the weekend press as saying he didn't believe in mergers and that any approach would be rebuffed. His remark was a general one, intended to convey the company's determination to remain independent. So he was somewhat surprised to see it linked with the name of Barclays. He hadn't intended it that way. As is often the case in the press, he seems to have been taken out of context. So did it happen? Did Barclays approach him? Probably not, seems to be the answer, though it is easy to see why the stock market might think it true. The idea is eminently plausible.

Having decided to throw in the towel on investment banking, Barclays is under pressure to come up with an alternative strategy for taking the company forward. The idea of using the bank's established channels of distribution to sell other financial services, such as insurance, endowments and pensions, is hardly a novel one. Bancassurance has been around for many years now. But it is only relatively recently that corporate financiers have started to think in terms of the creating giant retail financial services conglomerates out of the merger of high street banks with life and insurance companies.

National Westminster Bank got quite a long way down the aisle with the Prudential before deciding to call it off, and a few years ago, Halifax bought Clerical Medical. It is therefore entirely possible that Barclays is thinking in the same terms - a takeover of L&G, or possibly Norwich Union, with which it already has links. Would such a union make sense? A case can certainly be made for it. There would be little scope for cost cutting, unlike any consolidating merger within these separate industries, but there are obvious advantages to be had from funnelling the insurance company's products through the bank's customer base.

Moreover, as the borders between traditional forms of retail lending, account holding and other forms of saving become more and more blurred, there is obviously something to be said for the one-stop shop, the company that can offer all these services.

But do high street banks need to merge with insurance companies to create that opportunity? Royal Bank of Scotland has developed a highly successful relationship with Scottish Widows which delivers benefit to both companies, probably on a par with anything that could be derived from a full-scale merger, but without having to go through that process.

It is no accident that Royal Bank of Scotland is considerably more innovative in the banking market than most of its English peers, despite its comparatively small size. It was one of the first to introduce telephone banking and now has more of its customer base using this service than any other bank. It was also the first to introduce a fully fledged Internet bank and has forged some very promising bankinglinks with Tesco and Virgin Direct.

In part, Royal Bank is able to do this because it is comparatively small, with just 2 per cent of the UK banking market. For larger banks to go wholeheartedly into these new forms of low-cost banking would mean cannibalising their existing markets on a scale that would do irreparable damage to margins and profits. For Royal it is not the same. For every one customer it cannibalises from its existing customer base, it gains 50 others from rival banks.

The big clearers are highly vulnerable to these new forms of banking and are naturally, given the constraints of their existing cost bases and market shares, worried sick by them. It is against this backdrop that the pressure for mergers, both within the banking and insurance sectors and between these sectors, ought to be seen. All these plans are essentially protective and defensive in nature. If these companies were serving their customers properly with state of the art low-cost banking and insurance products, grand strategies like these, dreamt up in the City for the benefit of the City, wouldn't even be getting on to the chief executive's desk, let alone be coming close to execution. The fact that they are serves only the underline the failings of these ancient behemoths.