Roll up, roll up, for the great bank sell-off

But who will buy the pieces chipped off Northern Rock, RBS and Lloyds? Richard Northedge reports on the impact of Neelie Kroes's order

Early next year, a million Northern Rock savers and up to 200,000 borrowers will get a letter telling them their accounts will in future be with the "good bank" being split from the nationalised lender. The other 300,000 mortgage customers will be branded as "bad bank" clients, possibly because of arrears, but probably because Rock regards them as potentially risky.

It is the sort of unpleasant letter that will become common as competition is injected into British banking. Almost five million Lloyds group customers will be told in coming years they have been sold to another company – perhaps a supermarket or an insurance company or a foreign lender – and can no longer bank with Lloyds. The same fate is faced by 1.7 million Royal Bank of Scotland savers and borrowers.

If customers demand to move their accounts back to Lloyds or RBS after what might be a lifetime with their bank, it will defeat the aim of the European Competition Commissioner, Neelie Kroes – now backed enthusiastically by the Chancellor, Alistair Darling – to chip chunks off the existing banks to create new financial institutions. She has yet to say if she will ban banks from allowing, never mind encouraging, customers to remain loyal to their lenders, but many millions of customers will be compulsorily made to move banks.

Mrs Kroes (right) is demanding this unprecedented piece of corporate and consumer engineering as the price for RBS and Lloyds getting state aid. She has told Lloyds to sell 600 branches, including its Cheltenham & Gloucester chain and Scottish units, but also more than 400 Lloyds or Halifax branches in England. One in five of Lloyds' mortgage customers – perhaps two million people – will be affected, plus 3.5 million current account holders.

It has four years to complete its sale – the same timetable given to Royal Bank of Scotland, which must sell the 311 branches trading under that name in England and Wales, plus a handful of Scottish NatWest branches.

Customers at the branches earmarked for sale will have their accounts sold, like it or not. The divested RBS branches may be renamed as Williams & Glyn's , an old RBS brand, and the Lloyds branches could become TSBs, but the purchasers may well put their own marques on both buildings and bank accounts.

But who will buy remains unclear, even for Northern Rock's good bank, which could be sold next year. The one group that cannot purchase will be established banks such as Barclays, HSBC or Santander.

But, while the Financial Services Authority is keen to widen choice, any purchasers must pass its threshold conditions on integrity and managerial ability as well as providing adequate capital backing. As these sales are the consequence of the banking crisis, the regulator cannot lower its standards.

For every £100 a bank lends it must have £8 or more of reserves. So to take on £70bn of Lloyds' consumer lending a buyer will have to provide at least £6bn of capital on top of the price paid for properties and goodwill. That will eliminate many would-be buyers.

A financial innovator such as Virgin Money, for instance, would have to seek new finance and possibly new partners. Other names include Tesco, but it would rather put banks inside its stores – it already has six full Tesco Bank branches – so is an unlikely bidder. And while a supermarket might like Intelligent Finance, Lloyds' internet bank, Mrs Kroes insists it be sold in the same package as the branches.

Standard Chartered is a well capitalised UK bank with no British branch network, but while it is permitted to bid – and in the past attempted takeovers of both Lloyds and RBS – it now insists it will not do so because it prefers the fast-growing Asian market.

Buying a ready-made chain would offer an easy entry into the UK market for an established foreign finance house, but many European and US banks are trying to shrink their own balance sheets, just like Lloyds and RBS, and have no spare capital to support a purchase. Mrs Kroes last month ordered the Dutch ING to split off half its business because it too accepted government aid. BBVA of Spain might want to emulate Santander's expansion, but is currently growing in the Americas.

National Australia Bank, which owns Yorkshire and Clydesdale, would reap synergies from expanding its network but competition considerations could bar it from buying Lloyds' Scottish chain. National Australia and Santander prove that overseas buyers can now purchase UK banks. In the 1990s, when HSBC wanted to buy Midland Bank, it was forced to move its registered base from Hong Kong to London.

The single market means any European finance house can purchase a UK bank but, after the Icelandic debacle, the FSA would baulk at attempts by a foreign bank to operate through UK branches rather than a British-registered subsidiary that it would regulate. And it might worry too at a private-equity bid or one relying on venture-capital backing. That rules out a management buy-out. And those calling for Northern Rock to revert to a building society will be disappointed; the Treasury needs the proceeds of a sale.

A large insurance company such as Prudential or Aviva – or an overseas insurer – might consider a bank network, but past moves into "bancassurance" proved disappointing and Pru sold its Egg bank. Rather than acquire a chain of Scottish bank branches, Edinburgh-based Standard Life chose last month to sell its banking subsidiary. That Barclays bought Standard's bank shows the limited range of buyers.

A worry for buyers is that Lloyds and RBS are not being broken up, merely having parts chipped off. RBS has 2,264 branches including NatWest and Coutts and will keep 86 per cent of them; the 600 branches Lloyds will lose are part of a 3,000-strong portfolio.

Rather than break up banking's Big Four – six including Santander and Nationwide – the newcomer will have a small presence with regional biases. An entrant will lack scale but also the synergies available to those with existing clearing and computer systems.

But Peter Vicary-Smith, the chief executive of consumer group Which?, welcomed the expansion of choice: "New entrants offering genuinely competitive products will help address the complacency of the big names."

British retail banking has consolidated into a handful of lenders whose anti-competitive practices have concerned customers and the Office of Fair Trading. In the 1990s, Cheltenham & Gloucester, TSB, Lloyds, Leeds Permanent, Halifax, Birmingham & Midshires and Bank of Scotland were rivals: now they are a single group. RBS has swallowed NatWest while Barclays bought Woolwich and now Standard Life's bank; Santander followed its takeover of Abbey by buying Alliance & Leicester plus Bradford & Bingley's branches and savings business. Nationwide is now bigger than all other building societies added together.