Banks face backlash as profits soar 24pc

When Northern Rock announces its final results on Wednesday, it will set the tone for a bumper banking results season. The Newcastle-based bank's own profits before tax are expected to be up around 11 per cent compared with 2003, but even that healthy growth rate will look pedestrian compared with rivals such as HSBC and HBOS, which should enjoy growth of 37 and 21 per cent, respectively.

Indeed, the big nine quoted British banks are expected to have earned more than £40 billion between them last year, almost a quarter up on 2003. Add in the £700 million or so expected from Abbey National, now owned by Spanish bank Santander, and the figures look even more spectacular. So how can banks' profits be so resilient when so much of British business are finding life so tough?

Much credit, literally and figuratively, goes to consumers. For most of the past five years we have been indulging in a borrowing spree as soaring house prices and - until last year - falling interest rates - made us feel rich. Consumer borrowing has been rising by well over 10 per cent a year for the past three years and now stands at more than £1 trillion.

Banks have been benefiting handsomely. In its December trading statement ahead of its results, Northern Rock said that its residential mortgage lending was up 37 per cent on the previous year; HBOS, owner of the Halifax and Bank of Scotland, said it would 'comfortably exceed' the City's profit expectations due to lower costs, higher lending and better margins.

Last year was also a good one for corporate and investment banking. After a difficult few years following the stock market scandals of the late 1990s, businesses have started to regain confidence, which is reflected in higher borrowings and a gradual return of mergers and acquisitions. Most analysts expect that to continue, and possibly accelerate, in the current year.

While mortgage lending and retail sales figures point to a tailing-off of consumer confidence, analysts expect last year's bumper figures to be exceeded this year, helped by stronger corporate lending. Richard Staite, banking analyst at SG, said 2004 'was generally a good year for the UK banks, with strong consumer lending and a good performance in corporate and investment banking divisions. We will see record profits'.

He added: 'We expect the rate of increase will slow this year, but at the moment we expect that profits will get bigger in 2005. The level of profit will clearly hit the headlines and attract the attention of consumer groups.'

Indeed, one of the surprising things about the banks' profitability is that it comes despite repeated attempts by government and consumer bodies to curb what they see as profiteering by the high-street clearers.

The Treasury select committee has forced credit card companies to make their terms clear to consumers, including the cost of their high interest rates and penalty charges. A series of investigations have forced the banks to offer interest on their current accounts. Halifax has thrown down the gauntlet with personal current accounts offering generous interest terms. There have been countless headlines attacking reckless lending practices as some customers are driven to suicide by their huge debts. Which? (formerly the Consumers' Association) is constantly carping about hidden charges on current accounts and credit cards and uncompetitive rates.

The scale of profit growth expected this year means these attacks are likely to intensify. The banks claim that high charges and interest rates considerably above base rates are required to compensate for the risk of lending to individuals, but that is not borne out by the figures. Bad debts are close to record lows. Goldman Sachs estimates that, across the industry, provisions will be just £5.1bn on almost £1.2 trillion of lending - less than 0.5 per cent of total balances.

While the level of provisions is likely to rise slightly this year, they will still be close to historic lows. And with most economists predicting that interest rates are close to their peak and forecasting a gradual slowdown in the housing market, rather than a crash, it is hard to see where the pressure to raise provisions will come from.

'The only thing that could cause [banks'] profits to drop sharply would be a sharp increase in bad debts,' said Staite. 'That is unlikely. They would only increase if there were a sharp deterioration in the economy. Currently, not many are forecasting a recession in the UK so, for the time being, the environment remains stable.'

The only other cloud on the horizon is banking costs. Barclays raised eyebrows in December when itrevealed that its Barclays Capital investment banking business had added a third to its staff numbersin the first nine months of 2004 alone. It insists that is justified by the increase in business: investors will be watching to see if that remains the case.

The industry's profitability has not gone unnoticed. Abbey National has already been snapped up by Banco Santander. There are constant rumours that others are also vulnerable to a bid from overseas. Barclays' name has been linked with everyone from Deutsche Bank to Citigroup, while Lloyds TSB is said to have attracted attention from ABN Amro and Bank of America.

So far, however, these rumours have remained just that. Cross-border deals in banking are notoriously difficult to pull off and even harder to implement. They also give limited scope for cost-cutting because of the lack of overlap between the businesses.And a big cost-cutting merger between British banks has been all but ruled out by the competition authorities. But record profits from the sector will be all the more obvious given the pedestrian growth expected from elsewhere in corporate Britain. So banking bosses should be donning their hard hats ready to ward off consumer, and political, attacks.