QUALIPORT
Government Issues Banking Share Tips

By Maynard Paton (TMFMayn)
July 12, 2001

Carburton Street, London -- It's not often that the government doles out stock market tips. Yet on Tuesday, Patricia Hewitt, the Secretary of State for Trade and Industry, (indirectly!) highlighted a handful of great business "franchises". When investors receive such an official stamp of approval, it's time to take note.

I am, of course, referring to Ms Hewitt's decision to accept the findings of the Competition Commission and prohibit the merger between Lloyds TSB (LSE: LLOY) and Abbey National (LSE: ANL).

Hewitt declared: "[The merger] would reduce competition in the markets for personal current accounts and banking services for small and medium sized enterprises, with the adverse effects in both markets of higher prices to customers and reduced innovation."

While there are arguments for and against the DTI's decision, what isn't in doubt is the ongoing dominance of certain banking services by the four leading High Street players (Barclays (LSE: BARC), HSBC (LSE: HSBA), Lloyds TSB and Royal Bank of Scotland (LSE: RBOS)/NatWest -- "the big four").

The DTI stated the following on Tuesday, all of which is Good News for existing shareholders of the big four banks:

"The Commission concluded that that it was important for competition that there are well-established rivals to the big four banks because:

* the entrenched position of the big four remains strong;

* there is very little switching between banks by customers;

* telephone and Internet-based providers, as alternatives to branch- based (multi-service) providers, remain niche players only, and;

* branch-based players entering the industry in the last 10 years have grown only slowly despite offering better terms than the big four."

So, even after the introduction of telephone and Internet banking from supermarkets and the like, plus the arrival of countless branch-based former building societies into the fray, the big four banks still remain "entrenched" in a strong industry position.

For some reason, as the Competition Commission confirmed, the general public remain loyal to their old banking favourites. Significantly, even despite "offering better terms" than the big four, newcomers have found it tough to muscle in on the patch of Lloyds TSB et al over the past ten years!

In general, it's all welcome news for the Qualiport and other Lloyds TSB shareholders. It should also be music to the ears of any investor looking for great long-term businesses too. It's obvious that the big four banks have some sort of moat around parts of their business that others find extremely difficult to cross.

Commodity

But can the big four banks remain dominant for the long-term? I think so.

Retail banking is largely a commodity industry. If you want to get a foothold in the sector and attack the big four's dominance, you'll need:

* Innovative products to help you stand out from the crowd and get noticed. Apart from your rivals' eventual copycat products, the problem with innovation is that you have to appeal to the notoriously conservative and lethargic nature of your typical banking customer. For instance, changing your branch-based account to a new-fangled Internet-based one can simply be too much trouble to contemplate;

* To offer better terms than your rivals. Unfortunately, for products such as current and deposit accounts, decent offers tend to attract the wrong sort of customer. "Rate chasers" who flit from one bank to another just aren't that profitable. Instead, it's people like me -- 17 years man and boy a customer of NatWest -- who keep far too much money in their 0.1% yielding current accounts that the banks make their money from.

* Pots of money. Innovative products offering better terms require plenty of up front capital. In my view, only a well-resourced foreign bank acquiring one of the UK's smaller banks would pose a real threat to the status quo.

Predictable

In short, the shareholder odds are still very much with the big four banks. Undoubtedly, competition will nibble away at their dominance in years to come. However, that could be offset slightly by any further, albeit almost certainly minor, consolidation in the sector.

Relatively speaking, the UK's banking industry is one of the most predictable in terms of judging the long-term winners. While sensitive to the vagaries of the economy, and subject to some sort of acquisition faux pas, you just know that the same old faces will still be dominating the UK sector in the years to come. As the DTI and the Competition Commission confirmed on Tuesday, it's still proving delightfully difficult for new entrants to gain a sector foothold.

More: Lloyds TSB discussion board | DTI announcement in full