It's a wonderful bank??

Can Alastair Darling make the British public love its banks again? Right now, attitudes to banks are thoroughly poisoned. Long before the credit crunch, people were angry over the endless electronic menus, the impersonal call centres replacing branches, the mind-boggling overdraft fees, product mis-selling and on and on. The credit crunch added monster bonuses, giga bailouts, falling deposit rates and vanishing credit to the litany of grievance.

It wasn't always this way. Older people may still recall the days when their local bank seemed like the Bailey Building and Loan Company in "It's a wonderful life". George Bailey was a philanthropic pillar of the community, known and loved by young and old alike, and there was a time when many people may have looked on the manager of their local branch in much the same way. Strange to say, Bailey Building and Loan wasn't actually the local bank of the fictional town of Bedford Falls. In fact, the banker was the villain of the piece, and drove George to the brink of suicide. So perhaps not so much has changed.

Back in the real world, the highly-localised US banking system portrayed in "It's a wonderful life" has been in decline ever since the Great Depression. There are still many more small banks in the US than in any other developed country, but the number is falling year by year. There are many reasons, good and bad, why banks tend to grow by consolidation. Among them:

* diversification of both assets and liabilities is a good thing. A bank whose activities are entirely confined to a small community like Bedford Falls is unlikely to find things easy over the course of a business cycle. Assume, for instance, that Bedford Falls is an agricultural town. When crops are good, all the clients will be cash rich. The bank will be awash in deposits and struggling to find suitable loans. In leaner years, deposits will fall and the bank may have trouble providing the loans that its clients suddenly need. In a really bad year, the loans will go bad and the bank will struggle to remain solvent. A reasonable level of diversification, geographical or across industries, can help to mitigate those problems.

* as people became much more mobile over the course of the last century, they expected to be able to take their bank with them as they moved around. Local banks could try to deal with this demand by setting up agency arrangements, but this was quite literally a mediaeval approach, and a very cumbersome one at that. At some point it became much simpler for banks to merge.

* there are overheads that have to be met whether you have one branch or a hundred or a thousand. Auditors, lawyers, marketing and so on are much more onerous expenses for a small bank than for a large one.

* as a particular sub-set of the previous point, back-office automation is both hugely expensive and massively scaleable. When I was working for one of the "Big Five" in Canada, it was generally accepted that each bank had a back-office system that was capable of handling the daily clearing, monthly payrolls and everything else for the entire financial system. This point was fully proven when several Canadian banks merged their back office and programming systems in the late 1990s in order to cut costs. Matching the electronic services that a large bank can perform on behalf of its customers would be prohibitively expensive for a small bank.

In the UK the number of clearing banks has been falling for decades (anyone remember National Provincial -- itself the result of a merger -- or Martins Bank?), but until recently the building societies provided a reasonable alternative. Then along came the Decade of Greed, and almost all of the building societies demutualised, often under pressure from carpetbaggers. In no time flat they were either voluntarily taken over by the banks (C and G, Abbey), forced into mergers with banks after getting themselves into trouble (Bradford and Bingley) or -- the the case of Northern Rock -- driven to the brink of failure. The dominance of banking services by the clearing banks was reaching uncompetitive levels even before the government overrode competition laws in 2008 to permit the takeover of HBOS by Lloyds, a move that has proved near disastrous for the government and Lloyds alike.

All of which is a lengthy preamble to suggesting that Alastair Darling's plan to break up those banks that have received the most state aid (RBS, Lloyds and Northern Rock) may be no more than spitting into the wind. Spinning the old Williams and Glyns Bank out of RBS, or TSB out of Lloyds, as the government (prodded by the EU) now proposes, will only add marginally to the amount of retail banking competition in the UK. In fact, it may not even do that. There are already suggestions that Santander, not exactly a minnow, may seek to add Williams and Glyns to its own burgeoning empire, alongside Abbey and Bradford and Bingley, erstwhile real competitors whose venerable names will disappear at the start of 2010. Even if W & G or TSB were minded to stay independent, could they afford the computer systems that would be needed to compete with the larger firms, or would they continue to use the systems of their former parent? And if by chance they were successful, how long would it be before the initial buyers decided to cash in and sell to a bigger firm at a huge profit, prompting a public outcry over foregone profits for the taxpayer?

Bank of England Governor Mervyn King declared a couple of weeks ago that there was a strong case for breaking up the banks. He was rounded on by the Government for daring to say so, even though Darling et al must have known by that time that they were about to be forced by the EU to do precisely that. King hasn't been heard from yet on the government's specific plans, but it's a good bet that he thinks they aren't radical enough. But even if they were, it's unlikely that Sir Fred Goodwin and his ilk will emerge as the George Baileys of the modern age.