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Outlook: Danger signs as banking enters the late cycle

WHEN a chain of downmarket womenswear shops can go for pounds 350m and a London socialite/restaurateur can net pounds 5m simply by catering for ladies who lunch, then we have most certainly reached what the Bank of England likes to call the late stage of the economic cycle. This is the point when the froth rises to the top and any deal seems possible. In the late 1980s the moment was encapsulated by the Saatchis' bid for the Midland. A decade on we are waiting for the late 1990s equivalent.

There are two prerequisites for this kind of late cycle activity. One is a belief that the good times will last forever. The other is a banking system awash with surplus capital. Put the two together and what normally results is some very poor lending and some even more spectacularly bad debts a couple of years down the line.

This time around, as yesterday's valedictory Banking Act report suggests, there is little evidence of the kind of reckless lending to property ventures that came home to roost in the 1990-1992 recession.

Instead, the banks seem to be gearing up to use their surplus capital to take one another out or indeed any other financial services provider that shows the slightest interest in a spot of consolidation. Thus we have had Merrill Lynch-MAM, UBS-SBC, Pru-ScotAm and what will probably turn into a wave of bancassurance mergers starting with Halifax-Clerical Medical and the daddy of them all, Citicorp-Travellers.

Michael Foot, who formally moves over from the Bank to the new Financial Services Authority in 10 days time taking his regulatory responsibilities with him, reckons there will be a lot more of this sort of activity.

With NatWest talking to the Pru and Abbey National and Barclays courting NatWest or is it Standard Chartered, who is to say he is wrong? Yesterday's rumour had ABN Amro and Bear Sterns one step away from the altar.

With financial services consolidating like this it makes sense to have a regulatory structure which mirrors the shape of the industry it is policing, or so the argument goes. When Mr Foot shifts over to become managing director and head of financial supervision at the FSA, he takes everything with him save for preventing systemic risks undermining the whole banking sector.

That means the Bank will still have a say should another Asian crisis put lending policies under the spotlight.

But he will be busy enough. The combination of vaulting ambition, and mega financial rewards which is driving the consolidation in financial services, increases the temptation for risk taking and thus regulatory failures. Mr Foot will have his work cut out.