Why Fred must keep growing

AT A conference discussion recently on what the future held for European banking, the expert view came back that there would be one big German bank, one large French bank (and so on) and five affiliates of giant American banks based in Britain.

We may be some distance from such an outcome, but this is more than just a silly story. Royal Bank of Scotland's £7.1bn of profits might seem like a great deal, but it is still shy of Citigroup, which made just short of £10bn.

RBS has choices. It can do the complacent thing, which is to preen itself on how successful it has been and buy back its own shares. The risk is that it will be seen as no more than a British regional bank with a few add-ons, and be bought up by an American predator.

Or it can continue on its expansion path, ignore the consumer barbs about super-profits and move more deeply into the businesses in which it has been expanding. These include east-coast banking in the US and general insurance which, through Direct Line and Churchill, have become a cash-generating machine.

What is clear is that Britain's big banks are reaching the limits of their expansion within these shores. The Continent has proved difficult territory to conquer despite the long search by Lloyds TSB and others for partners.

In retail banking, Barclays' main inroads have been in Spain - not in the dominant EU countries. With its credit card franchise, Barclays Global Investors and capital markets business, Barclays would make an excellent dish for one of the US banks. This is why Bank of America took a close look before settling on Fleet in Boston - for the time being.

The extraordinary growth at RBS in recent times, making it the world's fifth-largest bank, is largely due to the reorganisation of NatWest.

Throughout RBS's expansion, chief executive Fred Goodwin has managed to bring down the ratio of costs to income, which fell again to 42% from 44% over the last year. Some of this impetus will fade away as integration benefits recede.

But, like the other banks confined to these isles, RBS faces some enormous strategic choices if it is to keep growing.

Sarin's strategy

VODAFONE shares have climbed 5% since the AT&T Wireless deal fell apart on Monday, contributing - along with RBS and Reed Elsevier - to a good run for the Footsie. Now that the dust has settled, the rationale for Vodafone's widely criticised move on AT&T Wireless is starting to emerge.

Arun Sarin, the chief executive, is making it clear that he only proceeded on the basis that any deal would be done in conjunction with US partner Verizon. If Vodafone's ceiling bid of £20bn had succeeded it would simultaneously have exited from Verizon Wireless at an attractive price, which would also have given it full control of Vodafone Italy (Omnitel) and a better tax outcome.

Vodafone has told broker Goldman Sachs that, had its ceiling price been accepted, AT&T Wireless would have been cash flow positive in year one and earnings neutral by year three.

Having looked at other choices in the US, including Sprint PCS and Nextel, Vodafone has ruled them out.

Obviously AT&T Wireless was going to be a huge management challenge given its poor quality network and investors naturally are concerned about the wrecks of British companies expanding in the US. Nevertheless, given the cash flow machine that Vodafone is, generating £7bn a year, it could almost certainly have ridden out the storm.

As for the future, Sarin plainly is not going to be rushed into an expensive bid for Vivendi/SFR in France as an alternative. But he does regard Eastern Europe and Russia as expansion opportunities and he has not given up on consolidating the minority in Omnitel.

Now he has had a good sleep, Sarin is back on the case.

Brown's borrowing

A GLIMMER of light comes from the latest public sector borrowing figures. The January surplus of £4.4bn is down on last year, but the underlying trends are a little better. Public spending has been more tightly controlled and VAT receipts are up sharply (reflecting buoyancy on the High Street).

However, both income tax and corporation tax receipts are lower, although this may reflect a quirk of the calendar. There is a new-found confidence that Gordon Brown can confound his critics and bring the 2003 borrowing figures in within his Pre-Budget Report target of £37bn.

With the help of Sir Peter Gershon and the June spending review, he may then begin to slice into borrowing in 2004. But more of that in the St Patrick's Day Budget.