Commentary: A fine idea in theory

For the size of the economy, Britain's merchant and investment banks have the highest share of international financial market business of any in the world. Research published in the latest National Institute Economic Review finds them successful and flourishing in many of the most important capital markets.

The work, by Anthony Smith, was funded by the Bank of England, the Treasury and a number of City firms, including the four biggest clearing banks. He comes down against the view that tentative moves over the past few years towards universal banks on the continental model have been good for the City. Merchant and investment banks succeed better on their own, and do best in countries where the functions have been separate, such as the United States, Japan and to an important extent the UK.

If the City made a mistake in the mid-1980s, it was to see takeovers of investment banks as only worthwhile if one party was a larger commercial bank. Banks specialising in the capital markets would have done better to merge among themselves rather than look for a partner or fight to stay independent.

The best way to improve Britain's performance in the capital markets would be a restructuring to produce fewer, larger independent investment banks, the research suggests. This may be a good idea in theory. But cultural and personality differences have tended to block large merchant banking mergers, and there is little reason to think that has changed.

Mr Smith's research is based on an analysis of market shares judged on fee income from international corporate finance, syndicated loans, international bonds and equities, Euro certificates of deposit, commercial paper and Euro medium-term notes. He also interviewed a range of firms in different countries.

In sheer size, the US dominates these markets, with a 66 per cent share, compared with 17 per cent for Britain and a surprisingly low 5 per cent for Japan and 0.8 per cent for Germany. But adjusted for the relative size of the economy, Britain is ahead of the US, with Switzerland a poor third and Germany almost off the scale.

Success in international capital markets is, Mr Smith believes, associated with unprotected domestic markets and exposure to untrammelled international competition. He says there should be an opportunity for British investment banks on the Continent, as markets open up, because the universal banks are less efficient.

Of course, that could all go wrong if universal banks move first, and snap up the City's independents, as Deutsche Bank did with Morgan Grenfell. Next on the block is Charterhouse, which is to be sold soon to a continental bank.