Outlook: Europe overbanked? Pull the other one

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Martin Taylor, chief executive of Barclays, has asserted in a number of recent interviews that Europe is "overbanked". This is not a concept most ordinary banking customers find easy to grasp, for despite the burgeoning number of high street banks and Mr Taylor's belief that we need less of them, banking profits are booming and most British banks are throwing off excess capital like there's no tomorrow. In these circumstances, the need would seem rather to be for more competition, not less. So what does Mr Taylor mean by overbanked?

Plainly there's a sub text here, for Mr Taylor believes that regulators can eventually be persuaded that Barclays be allowed to merge with another sizeable British bank like NatWest. Though he acknowledges that such a merger would raise serious competition concerns in particular market segments and regions, he argues that these could be overcome through disposals. In any case, any merger of this sort should be viewed not in terms of narrow domestic market concerns, Mr Taylor believes, but in the wider European context and in particular in the light of imminent European Monetary Union.

With monetary union comes the reality of a single European market in banking and other forms of financial service. Most companies will progressively require just one bank to deal with their European needs, not as at present a bank in each country. The same argument can be applied to retail banking. When in matters financial, Britain, Germany, France, Spain and the rest are as one, do we really need so many banks? The dynamic of the market place, bankers like Mr Taylor argue, will force a series of mergers and takeovers among the present plethora of national banks to create a limited number of pan European super banks. Already we are seeing one attempt at this with the mooted merger of Union Bank of Switzerland and Swiss Bank Corporation.

These pressures are not confined to banking. Most chief executives of large international companies make exactly the same sort of arguments about their own industries. But because banking is all about money, the effects of European monetary union do take on a special significance when applied to this sector.

It is therefore vitally important that regulators get these decisions right when banks and other financial services organisations come hammering at their door for permission to merge. Do Mr Taylor and others like him have a point, or is this just a case of dressing up an old and fundamentally disreputable ambition in new clothing? Is not this in the end all about the businessman's natural desire to acquire the competition so as better to crunch and exploit the customer? If it is, how handy that monetary union should provide such a splendid new justification for this time honoured endeavour.

A new book on the banking industry, The Banking Revolution - Salvation or Slaughter, provides a useful insight into the commercial pressures on this industry, though it doesn't pretend to offer policy makers answers on how to deal with the creation of European super banks. Written by a group of consultants from the Mitchell Madison Group, the book is about the impact of information technology on the industry and it paints what in some respects is an apocalyptic view of the future for the present market leaders.

No bank can afford not to invest in information technology, the authors point out, because it would then get left behind. The problem is that as they do so, their profits begin to drift away since their cost structures are not changing fast enough to allow them to generate sufficient returns.

The effect of IT therefore is simultaneously to increase value for users of bank services while destroying the profits of the providers. Technology has made possible the provision of enhanced services at lower cost; it has enormously increased capacity while diminishing the need for labour, thereby working in favour of consumers rather than shareholders and workers.

One of the results of this is greatly to increase the pressure for consolidation and for expansion into other areas of financial services as organisations attempt to defend present rates of return and market positions. The question for regulators is not just whether it is appropriate to allow banks the luxury or this response, but also whether present lines of regulation are sufficient to the task of customer protection.

IT has allowed the blurring of channels of distribution and product in a way that creates pressure for cross financial industry consolidation. It is partly in response to this process that Britain is setting up a super regulator, the Financial Services Authority, which brings together previously separate and industry specific forms of investor protection and supervision. Government regulation is thus already beginning to mimmick the pressures of the market place.

So is Mr Taylor right about this after all? Or to put the question more correctly, should policy makers be allowing the old established organisations of banking a special dispensation because of the way IT and the single market are transforming their industry? What the Mitchell Madison book shows is that because the cost of large scale information processing has been declining by orders of magnitude for many years now, established banks cannot help but invest in it. By doing so they are creating over- capacity and reducing the barriers to entry as technology becomes more widely accessible and reduces the scale required for low cost operation.

This in turn has encouraged a range of new entrants - supermarkets, other financial institutions like Standard Life and the Prudential, and entrepreneurs such as Richard Branson. Furthermore it has allowed smaller banks such as Royal Bank of Scotland not saddled with the cost of an extensive branch network an unprecedented opportunity to raid the customer base of larger players with new, low cost products. The book warns "the potential exists that radical innovation could undermine traditional banking and that defenders are unprepared and vulnerable". In these circumstances, is it not only right and fair that established banks be allowed to merge?

The arguments might seem finely balanced, but in the end the answer has to be no, at least for the time being. Yes Europe is "overbanked", but not in the sense that Mr Taylor means it. The overbanking is in the form of tired old established players whose response to the process of change is to reach for the nearest investment banker and begin planning to take each other over. Mr Branson doesn't believe Britain or Europe to be overbanked, and nor does Standard Life and the many others now entering the market for the first time.

There is really only one good argument for allowing big established banks in Britain to go this route. The possibility, already apparent in the Swiss banking merger, that regulators in other countries allow their national banks to consolidate would undoubtedly put players like Barclays not allowed to do the same at a serious competitive disadvantage in the single currency. However, this could easily be dealt with by applying a consistent European wide approach to mergers policy.

If established banks are allowed to consolidate their position there is a real risk that they will use their power to stifle new entrants and the process of change will at least be slowed. The customer, who for a change is beginning to get the upper hand as things stand, would lose as a result. The market should be allowed to work its ways and established players must either adapt or die.