The financial folklore that cannot be banked on

On the latest lessons for banks

We are re-learning two old lessons about banking this autumn, and - maybe - learning two new ones.

One of the old lessons is highlighted by the news of the merger yesterday of two of the three big Swiss banks. For anyone who follows banking the fact that there should be three big Swiss banks is part of the folklore. Banks in other countries might merge, be taken over, or even fold - more of that in a moment. But the three big Swiss banks seemed unassailable, symbols of Swiss solidity and competence in international banking.

That view was wrong. It was wrong because anyone who took that view was forgetting that the dominant theme in banking is still one of consolidation. Banking, particularly international banking, is becoming more and more a commodity business, where it is very difficult for any bank to sustain a comparative advantage over the others. As margins become compressed, size matters more and more.

The practical illustration of that is the shedding of labour planned by the Union Bank of Switzerland and the Swiss Bank Corporation: the present joint workforce of 56,000 will be trimmed to 43,000. Those 13,000 people are simply not needed, for the merged bank reckons it can do the same amount of business without them.

Wherever you look in the world a similar process is taking place. Even here in Britain, which has experienced several waves of consolidation, being reasonably big seems to be no sure protection - neither NatWest (itself the product of a merger) nor Barclays seem entirely certain to remain independent entities. At some stage consolidation will stop. That will happen when there is little or no advantage to be gained from further economies of scale. But at the moment the long-term trend remains established.

The second lesson of the autumn comes from a different part of the world, East Asia. This is that banks should not become too close to their clients, particularly their commercial clients.

"Relationship banking", where the bank seeks to have a long-term relationship with its clients, has long been touted as a preferred alternative to "commodity banking". From the bank's point of view, binding in a customer in some kind of long-term relationship ought both to enable it to know more about the customer's business and to earn a higher margin because the customer is not shopping around for the cheapest service. And from the customer's point of view, a long-term relationship should ensure more support if things start going wrong.

There are undoubted advantages in the relationship model, particularly in good times. But - and this is the lesson of the autumn - it carries the most profound dangers when things turn down, for when a bank's customers are under pressure, too close a relationship also threatens the bank.

The East Asian banking model, where banks are bound into commercial empires with cross-holdings, is currently crippling the recovery in Japan, for the high proportion of non-performing loans not only undermines the bank's balance sheet, but it inhibits them from seeking new business. So creditworthy companies are unable to borrow because the banks that might lend to them are too frightened by their weight of bad debt. Of course, in several East Asian countries, cronyism and in some cases fraud have exacerbated the problem. But even without that the model has been shown to be flawed. It will be interesting to see how long it will take for British enthusiasts of the Japanese banking model to acknowledge its evident weaknesses.

Those are the two old lessons. What about the possible new ones? One is that to be a banking name is not necessary to be a bank.

Banks, seen as a brand, have extraordinarily longevity. The two main Scottish banks, Bank of Scotland and the Royal Bank of Scotland, date back to the seventeenth and eighteenth centuries. The four main UK clearing banks go back, in various forms, to the last century. The Midland name has survived change of ownership to the Hong Kong and Shanghai Banking Corporation. Compare that longevity with the brand names in, say, the motor industry. Austin? Morris? Hillman?

But the last year has seen the most serious challenge to banks as brands, and it is happening here in Britain. Suddenly we have new banks - Tesco, Sainsbury, Virgin. The stores groups had been chipping away at the fringes of the financial service business for some time, for example by Marks & Spencer offering unit trusts. But the success of the supermarkets as deposit-takers is something new.

Go back a quarter century and everyone thought that money was different. People might be prepared to buy strange brands of coffee or soft-drinks (though, in fact, the brands there are pretty stable); they might experiment with new stores; but banking was banking. So while there would be competition within banking and competition for deposits from other established financial institutions such as the building societies, no new banking brands could be established.

The first challenge to that came from First Direct, where Midland, at that stage still independent, deliberately did not use its existing brand name for this new style of banking, but developed another.

The word "direct" then became a generic term for financial services sold and handled over the phone. But people did know that Midland was behind the venture, which gave them a certain confidence. With hindsight I suspect that, had the venture been called Midland Direct, growth would have been even faster and the banks might have retained their independence.

The second challenge came from other established brands, the retailers. This was not entirely new - there was, after all, already a Harrods Bank - but the idea that one sort of brand can be transferred to an entirely different type of venture really would have seemed astounding 25 years ago.

So the first of these two new lessons is that brands in finance are transferable. The Virgin brand, based on a record company and only a generation old, is evidently as good as bank brands which have taken centuries to build.

And the second new lesson? Well, it is not really a lesson, more an observation on the East Asian banking crisis. It is that for personal business at least, banking brand names do not seem to cross national boundaries very well. I should think most of us are quite glad that we do not have an account with a Korean or a Japanese bank.